Impact of fossil fuel subsidy reform in China: estimations of household welfare effects based on 2007–2012 data

Changing the energy subsidy mechanism is a priority of China’s ongoing market-based energy reform. Using the 2007–2012 empirical data, this paper applies an input–output model to evaluate the welfare effects, that is, the expenditure increments of five income groups in 28 provinces, associated with the possible policy scenario of removing the subsidies for fossil fuels. The key findings of this study include, first, that the total indirect welfare effects (i.e. the additional money spent on non-energy commodities) are two-to-three times as large as the direct ones (i.e. the additional money spent on energy). Second, removing the oil subsidy leads to an additional expenditure of 19.74 CNY annually for each resident, which is much larger than the effect of removing the natural gas and coal subsidies. Third, the composition of the indirect effect varies significantly among income groups, because food expenditure contributes to approximately two-thirds of the total indirect effect on average. Finally, the welfare effect is very sensitive to the income level. To promote the smooth reform of the fossil fuel subsidies, we suggest that the government should deal with the coal industry initially, pay special attention to the indirect expense increase, and compensate low-income households for the welfare losses.