The Iranian government recently announced their intention to phase out several of its subsidies. The reform bill, the outlines of which were approved by the parliament in November, aims to eliminate subsidies over a five year period, the most notable being Iran's fossil-fuel subsidies. The reforms will also apply to subsidies for water, food and some services (post, rail and air transportation for passengers).

According to the International Energy Agency (IEA), Iran is the world's largest subsidizer of energy, spending over US$ 55 billion in 2007. In total, according to Reuters, subsidies are thought to cost the leading OPEC oil producer up to US$100 billion a year.

The cost of these subsidies is not just financial. Cheap energy has encouraged inefficient consumption patterns, creating an artificially high level of demand. This wastes energy and, because Iran's main source of energy is fossil-fuels, increases pollution.

The energy subsidies, which are intended to shield consumers from high and volatile prices, have been shown to be an inefficient means of transferring benefits to low-income households. Shams Al-Din Hosseini, Iran's Minister of Economics and Finance, has stated that 70% of the spending on subsidies goes to the country's richest 30%.

Under the proposed targeted cash-transfer system, people will receive payments based on their income, giving low-income families greater purchasing power.

There is a long history of subsidies in Iran, and previous attempts to reduce or eliminate them have failed.

In 1974, responding to the high rate of inflation and price volatility, notably in the market for petroleum products, the government established a Consumers Support Fund, to control prices and distribute subsidies. In 1977, the Fund was replaced by the Organization for Protection of Consumers and Producers (OPCP). Iran's oil production declined in the wake of the 1979 Islamic Revolution, and as a consequence of high inflation and growth in the black market, the government had to increase subsidies again.

Iran's second Economic Development Plan (1995-1999) called for reducing expenditure on subsidies, but instead subsidies as a percentage of the government budget continued to rise. Reform efforts were similarly unsuccessful in the third (2000-2004) and fourth (2005-2009) Economic Development Plans, despite the fact that the government had been instructed to carry out extensive research to develop a plan for subsidy reform.

Observers attribute past failures to reform Iran's massive subsidy system to the government's fear of the consequences of sudden price rises. As time went on, and the more the populace grew accustomed to artificially low prices, the harder it became to contemplate subsidy reform. The government is hoping, this time, that providing targeted cash transfers to the poor while gradually eliminating subsidies will make it politically feasible.

Compared with price subsidies, targeted cash transfers have numerous advantages. Because people can choose how to spend their money, it leads to a more efficient allocation of resources. At the same time, the demand for fossil fuels can be expected to decline, in response to higher prices. Bringing domestic prices into line with world prices would also eliminate the current incentive to smuggle petroleum products out of Iran to neighbouring countries.

The extra revenue freed up by the subsidy reforms will provide the government with more funds for investment in infrastructure, and the higher fuel prices will spur producers to make their production processes more energy-efficient. As it is, Iran does not have enough refinery capacity to satisfy its domestic demand - so the fastest way to become resilient against possible trade sanctions affecting petroleum products is to reduce demand itself.

However, critics argue that household-income data are insufficiently detailed to implement the proposed plan, and as a result the government might not meet its target of achieving a more just distribution of income. They note also that the plan might trigger inflation and harm the economy. Accordingly, the speed at which the subsidized prices are raised will be an important factor in determining whether the reform succeeds.

How likely is Iran's subsidy reform to succeed?

This time, Iran's government is seriously pursuing subsidy reform and is trying to develop robust implementation strategies. Notably, it has proposed the establishment of an independent organization to administer its targeted cash transfers which needs to be approved by the parliament. And, thanks to extensive debate, the country's citizens are also more informed and may be better prepared to accept change than they had been in the past.

The threat of trade sanctions targeted at refined petroleum products, particularly gasoline, also adds urgency for the government to turn the reform plan into action and decrease the domestic demand for these products.

Taking these elements together, the probability that the government will follow through with its plans has increased.

However, overall success of the plan depends on actions that the government will have to take to control inflation and to accurately determine which households merit targeted cash transfers.

As of 1st December, the bill still needs to be approved by Iran's watchdog Guardian Council, and was at the centre of some discord about how the saved revenues could be spent. "If the bill does not provide the necessary capacities for government to implement it, then we would withdraw it from the parliament," the IRNA news agency quoted President Ahmadinejad as saying on 2 December. "If necessary, we will propose another bill."