The Welfare Effects of Explicit and Implicit Subsidies on Fossil Fuels

We examine the welfare effects of removing explicit and implicit fossil fuel subsidies, the latter entailing Pigouvian pricing of local externalities from fossil energy consumption. We map a multi-region, multi-sector general equilibrium model to granular data on subsidies, local marginal external costs, and national income and product accounts. On average, unilateral Pigouvian pricing improves a country’s welfare by 3.7%, generates fiscal revenues equal to 2.5% of consumption, and reduces the carbon price needed to meet the Paris climate target by 76%. Non-market welfare gains exceed market-related losses, benefiting most countries. Local air pollution pricing accounts for 90% of net benefits. About one third of countries would already meet their climate targets, making additional policies like carbon pricing redundant. For all countries combining Pigouvian energy pricing with carbon pricing increases welfare compared to relying on carbon pricing alone. Removing explicit subsidies has a minor impact on welfare and emissions. Global Pigouvian energy pricing would reduce global emissions by 32%, while increasing global welfare by 2.4%. Our findings underscore the potential of Pigouvian energy pricing to align economic, fiscal, and climate goals.

Kalmey, Tim, Sebastian Rausch and Jan Schneider (2025), The Welfare Effects of Explicit and Implicit Subsidies on Fossil Fuels, ZEW Discussion Paper No. 25-021, Mannheim.