Fossil fuel subsidy removal, economic welfare, and environmental quality under alternative policy schemes

The literature related to the environmental impacts of fossil fuel subsidies removal is inconclusive and fragmented, with non-negligible methodological shortfalls. Also, can the adverse economic effects of such subsidy removal be mitigated through government transfer payments to the firms and households? Taking the 2020 subsidy reform in Nigeria as a case, we developed the African Energy and Environment Integrated Computable General Equilibrium (AEEICGE) model to examine the economic and environmental impacts of fossil fuel subsidy removal. Our approach accounts for the substitutability of intermediate input demand for energy products. We find that although subsidy removal on fossil fuels improves environmental quality, such reform negatively affects the economic well-being of households and raises overall prices. We also find that the adverse impacts on prices and welfare are reversed when the subsidy is allocated differently to businesses and households through the government's transfer payments. Particularly, the subsidy removal makes a 0.25 bps contribution to aggregate inflation and leads to welfare losses of about ₦0.049 and ₦0.108 billion, on average, for the poor and rich Nigerian households respectively. Notwithstanding, their welfare can improve and gain, on average, about ₦15.89 and ₦78.96 billion respectively with the proposed resource reallocation schemes. Our approach and results not only resolve existing puzzles in the literature, but also offers both theoretical and practical implications that are pivotal for the scientific community, policymakers, and industry stakeholders alike.