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Fossil fuel subsidies are widespread in developing countries, where reform efforts are often derailed by disputes over the likely distribution of gains and losses. The impacts of subsidy reform are transmitted to households through changes in energy prices and prices of other goods and services, as well as through factor earnings. Most empirical studies focus on consumer expenditures alone, and computable general equilibrium analyses typically report only total effects without decomposing them by source. Meanwhile, analytical models neglect important open-economy characteristics relevant to developing countries. In this paper, we develop an analytical model of a small open economy with a preexisting fossil fuel subsidy and identify direct and indirect impacts of subsidy reform on real household incomes. Our results, illustrated with data from Viet Nam, highlight two important drivers of distributional change: (i) the mix of tradable and nontradable goods, reflecting the structure of a trade-dependent economy; and (ii) household heterogeneity in sources of factor income.

As a result of human economic activity, the planet Earth is facing a climate change emergency (IPCC, 2013). Scientific research suggests that bold and immediate solutions are required to avert the worst impacts of climate change (US Global Change Research Program, 2017). At the same time, societies are facing unprecedented levels of income and wealth inequality — often along the lines of race and gender — which threaten the very foundations of democratic governance (OECD, 2011)…