Analyzing the Effects of Reducing Energy Subsidies on Income Distribution in Iran by a Computable General Equilibrium Model

Energy is one of the most important influential factors in every economy. Energy is used as an intermediate input by firms, as a final commodity by households, and transportation costs are heavily dependent on energy. So analyzing the impacts of energy policies on the economy is very important. One of the common energy problems in many developing countries is energy subsidies. According to IEA, energy subsidy is any government action that lowers the cost of energy productions, raises the price received by energy producers or lowers the price paid by energy consumers. The most common reasons for the introduction of energy subsidies are lowering the cost of production, and consumption and alleviating energy poverty. However, despite some limited benefits, energy subsidy can leads to market distortion, substitution of energy with other production factors, increasing of energy consumption, reduction of incentives for energy efficiency, imposing fiscal burden on government budget, reduction of investment on other technologies of energy production, smuggling of fossil fuels, and environmental emissions. Therefore, reform of inefficient subsidies has the potential to provide substantial gain for the economy, and due to this reason, many countries, including Iran, started energy subsidy reform. Energy policy reform in Iran is multistep reform that the first phase of it began in December 2010, and other phases are going to be implement in the coming years.
Energy policy reform might have considerable effect on income distribution. Since income inequality might cause serious social, political and economical problems, the policy makers should consider the inequality effects of this policy reform. In this paper we analyze the effects of reducing energy subsidies on income level and income distribution in Iran. Analyzing the effects of exogenous policies and shocks on income distribution requires a method that incorporates both aggregate impacts on the economy and the heterogeneity of the effects on households. We used a computable general equilibrium model with heterogeneous households for the study of the effects of reducing energy subsidies on income distribution. This method provides a possibility to simulate the macro and intersectoral effects of exogenous policies, and the heterogeneous effects of policies on households as well. In order to incorporating heterogeneity of households into the computable general equilibrium (CGE) model, we disaggregated household sector in social accounting matrix into 100 rural and 100 urban representative households based on expenditure per capita. Then we estimated the parameters of households demand functions using micro database of household survey data, and then we construct and simulate the CGE model.
In terms of macroeconomic results, the simulations show that energy subsidy reform have decreasing and increasing effects, respectively, on GDP and inflation. In terms of distributional results, one of the advantages of the CGE model with disaggregated households by percentile of expenditure per capita is direct calculation of Gini coefficient. If the policy simulation increases Gini coefficient, then the policy can be thought regressive, and if it reduces Gini coefficient, it can be regarded as progressive. The simulation results show that lowering energy subsidies could have decreasing effect on real consumption of urban and rural households for all income quintiles, such that it reduce consumption of urban household more than rural one, and as we go to higher income percentile this decreasing effect increase with decreasing rate.