A key stated motivation behind energy subsidies is to protect household purchasing power,
especially among poor and vulnerable groups. However, they present a number of important
drawbacks. They generally are ineffective tools of social protection. Unlike food subsidies,
universal fuel price subsidies generally disproportionately benefit the rich more than the poor,
as they consume much more fuel. This is referred to as leakage in the targeting jargon.
Furthermore, fuel subsidies can distort energy consumption by reducing incentives for its
efficient use and discouraging use of alternative energy products. In this sense, they are directly
counter to current global efforts to reduce carbon emissions. Third, subsidies are likely to divert
resources from other social expenditures (education and health care in particular), which may
be more cost-effective at protecting the poor. Finally, the sustainability of these subsidies has
been questioned in recent years due to mounting subsidy costs and greater budget constraints
faced by many governments. In response, many Arab countries have started to reform their
price subsidy policy, especially for energy products.  
However, reforming the subsidy system raises a number of issues. Although reforming fuel
subsidies can improve a countries’ macroeconomic performance and ease fiscal pressures, the
associated price changes can generate direct and indirect adverse impacts on the welfare of
vulnerable groups and consequently on poverty. Indeed, subsidy cuts imply higher prices for
energy products (electricity, gas, petroleum, coal, etc.) directly consumed by households and,
perhaps more importantly, higher prices for non-energy products resulting from increased
energy input costs. Given these adverse effects on household welfare and the popularity of the
subsidies, many governments find it too politically dangerous to reduce or eliminate them. A
possible solution is to target compensatory policies to protect the most vulnerable and limit the
potential political instability. The question is thus how to reconcile subsidy reform and poverty
alleviation efforts, given that the resulting price increases (both direct and indirect) will impact
the poor to some degree?
The objective of this study is to simulate the poverty impacts of energy subsidy cuts where a
share of the budget savings are channeled to the most vulnerable – children living in poverty –
through the introduction of new child benefits. In order to do this, we develop a dynamic CGE-
micro model that is able to reconcile the large and complex general equilibrium effects of
energy subsidy cuts – where energy is a major household consumption good, production input
and direct source of employment – and the individual- and household-specific poverty and
inequality effects of the resulting changes in wage rates, employment, self-employment income
and consumer prices. The model is then used to compare the results obtained in a baseline
scenario without energy subsidy reform and a series of alternative policy scenarios developed
through discussions with local authorities. The analysis makes use of the most recent available
data from Egypt and Jordan.