MENA’s Path to Net Zero: Why Ending Fuel Subsidies is More Effective Than Carbon Tax

The World Bank and IMF study highlights that removing fossil fuel subsidies in MENA is more effective than a modest carbon tax in reducing CO₂ emissions, with no negative impact on long-term economic growth. It urges gradual subsidy removal followed by carbon taxation to ensure fiscal stability and a smooth transition to a low-carbon economy.

The World Bank, in collaboration with the International Energy Agency (IEA) and the International Monetary Fund (IMF), has released a groundbreaking policy research paper, authored by Hamid Mohtadi and Željko Bogetić. This study provides an in-depth examination of the role of fiscal policies in shaping carbon emissions in the Middle East and North Africa (MENA) region. By analyzing a dataset covering 41 countries worldwide, the research investigates the impact of fossil fuel subsidies, carbon taxation, and other financial instruments on greenhouse gas (GHG) emissions, economic growth, and energy consumption. The findings present a compelling case for policy reforms that prioritize subsidy elimination and targeted carbon taxation, offering insights into how governments can transition towards a more sustainable energy future.

Fossil Fuel Subsidies: A Key Driver of Emissions

A major finding of the study is that fossil fuel subsidies among MENA’s oil producers significantly contribute to higher carbon dioxide emissions. These subsidies artificially lower energy prices, leading to excessive consumption and wasteful energy use. Even after accounting for direct consumption effects, the study finds a residual impact of subsidies on carbon emissions, indicating that manufacturing and other industrial activities are also influenced. The effect is particularly pronounced in oil-exporting countries such as Saudi Arabia, Iraq, and the United Arab Emirates, where heavy subsidies distort energy markets.

When comparing different policy measures, the study finds that subsidy removal is often more effective than a modest carbon tax in reducing emissions. However, at higher carbon tax rates—$50 per ton of CO2 or more—taxation becomes a stronger tool for curbing emissions. This suggests that a gradual transition, beginning with subsidy reductions and followed by carbon pricing, would be the most effective approach for MENA economies.

Economic Growth and the Myth of Fuel Subsidies

The paper also explores the impact of fossil fuel subsidies on economic growth. Contrary to the belief that subsidies are necessary for economic stability, the study finds no statistically significant effect on long-term GDP growth. This contradicts the argument that reducing fuel subsidies would slow economic development. While there may be a slight short-term dip in growth, economies tend to stabilize as businesses and consumers adjust to new energy pricing.

Government budgets, on the other hand, benefit significantly from either a moderate carbon tax ($25 per ton of CO2) or the removal of fossil fuel subsidies. For countries like Saudi Arabia and Iraq, where subsidies are particularly high, eliminating them generates more fiscal savings than even a well-implemented carbon tax. The study suggests that the additional revenue from subsidy cuts can be redirected toward public investment in renewable energy, infrastructure, and social welfare programs, ultimately boosting long-term economic resilience.

Global Oil Prices and the Politics of Subsidies

The study also finds that global oil prices play a crucial role in determining the level of domestic fuel subsidies in MENA. When world oil prices rise, governments in oil-exporting countries tend to increase domestic subsidies to shield consumers from higher energy costs. This dynamic suggests that subsidy policies in MENA are not only shaped by internal economic factors but also by fluctuations in international energy markets. Given the volatility of global oil prices, maintaining high subsidies creates fiscal instability, making economies vulnerable to external shocks.

The research further highlights that flaring—the practice of burning excess natural gas—is a major source of emissions among MENA oil exporters. Despite global efforts to curb flaring, historical data indicates little progress over the past three decades. Iran, Iraq, Algeria, and Libya rank among the top nine flaring countries worldwide, contributing significantly to atmospheric carbon dioxide levels. This underscores the need for stronger regulatory measures and investment in gas capture technologies to mitigate emissions from oil production activities.

A Sustainable Future: The Path to Reform

The study includes country-specific projections using the Climate Policy Assessment Tool (CPAT), a macroeconomic modeling framework developed by the World Bank and IMF. The simulations show that for oil-rich nations like Saudi Arabia and Iraq, subsidy removal is more effective in reducing CO2 emissions than a modest carbon tax. However, at higher tax rates, taxation becomes more impactful. In non-oil MENA countries such as Egypt and Morocco, where subsidies are smaller, carbon taxation emerges as a more effective tool for reducing emissions. Fragile states like Lebanon exhibit a different pattern, where emissions are projected to decline steeply after 2032, independent of policy interventions, likely due to structural economic shifts.

From a policy perspective, the study emphasizes that increased transparency in fossil fuel pricing is critical for gaining public support for decarbonization measures. Many resource-rich countries in MENA have historically lacked transparency in their energy pricing mechanisms, limiting the effectiveness of reform efforts. The research suggests that international organizations such as the World Bank, IMF, and IEA should play a greater role in providing technical assistance and policy guidance to governments in the region. By improving transparency and communication, policymakers can build trust and mitigate resistance to energy pricing reforms.

The study ultimately challenges long-standing assumptions that fossil fuel subsidies are essential for economic development. Instead, it argues that phasing out subsidies not only reduces carbon emissions but also strengthens government finances and promotes economic stability. While carbon taxes can be effective, their impact depends on the tax rate and the presence of existing fuel subsidies.

The findings suggest that MENA economies should first focus on removing fuel subsidies before gradually introducing carbon taxes at rates that align with global decarbonization efforts. This sequence of policy reforms would ensure a smoother transition to a low-carbon economy while minimizing economic disruptions. By adopting these measures, MENA countries can position themselves for a more sustainable future, balancing economic growth with climate action.