Governments worldwide grant 7 trillion USD of subsidies for fossil fuels in 2022, equivalent to 7.1% of global GDP. According to a new study by the EU-funded Project WeLaR, eliminating these subsidies – especially implicit ones – could significantly boost economic welfare and help countries meet their climate targets.
Fossil fuels remain at the heart of global economies, but their consumption comes at a hidden cost – pollution, climate change, and lost tax revenues. The study, “Efficiency, Distributional, and Fiscal Effects of Climate Policy,” examines the local economic losses linked to fossil fuel subsidies and potential gains for countries from pricing fossil energy.
It finds that 95% of fossil fuel subsidies are implicit, meaning governments fail to charge industries for the local damage caused by fossil fuel use, such as health cost from local air pollution and costs related to oil use in motor vehicles associated with congestion, accidents, and road damage. The remaining 5% constitutes direct subsidies, where governments artificially lower energy prices through financial support.
“By correctly pricing energy, governments can unlock economic gains while reducing harmful emissions,” said Sebastian Rausch, co-author and researcher at the ZEW Leibniz Centre for European Economic Research.
The study shows that eliminating direct subsidies alone would lead to only modest economic gains for societies (0.2% on average). However, removing implicit subsidies by implementing taxation of local damages could increase economic welfare by 3.9% on average, with countries such as China, India, Russia, and parts of Europe seeing gains of up to 23%.
The fiscal impact is equally significant. Eliminating both types of subsidies could generate an additional 2.5 trillion USD in additional government revenue annually, equivalent to 4.9% of global consumption. Major EU economies such as Germany, France, and Italy could each collect billions in new tax revenues.
If these revenues were used to lower labour taxes, economic growth would accelerate further. Under such a policy shift, Germany, France, and Italy could see additional welfare gains of 0.28, 0.40, and 0.24 percentage points of GDP, respectively.
“The way revenues from fossil fuel pricing are used is crucial,” said Tim Kalmey, co-author of the study from ZEW Leibniz Centre for European Economic Research. “If they are used to lower labour taxes, the overall welfare benefits can be even greater.”
Eliminating fossil fuel subsidies could also have a major environmental impact, cutting global CO₂ emissions by 32%. This reduction alone would allow 40% of countries—including India, China, and Russia—to meet their Paris Agreement targets.
Challenges and Trade-Offs
Despite the clear benefits of eliminating fossil fuel subsidies, the study warns of unintended global consequences. Since fossil fuel markets are interconnected, one country’s policy shift can trigger economic disruptions elsewhere.
For example, Canada, Saudi Arabia, and Australia could face welfare losses due to reduced global demand for their fossil exports. On the other hand, most European countries, the US, China, and India would see economic gains from subsidy removal and pollution pricing.
“Despite these challenges, our findings suggest that subsidy reform could provide both economic and environmental benefits, and governments should accelerate their transition away from fossil fuel support” – said Sebastian Rausch.
Tim Kalmey and Sebastian Rausch (2024) Efficiency, Distributional, and Fiscal Effects of Climate Policy: The Case of Fossil Fuel Subsidies and Externalities. (Deliverable D6.2). Leuven: WeLaR project 101061388–HORIZON.
The full paper is available here.
