This paper examined economic and environmental impacts of reducing electricity subsidy in Kuwait. A Social Accounting Matrix (SAM) was constructed together with energy consumption with CO2 emission were compiled, and then calibrated with a computable general equilibrium (CGE) model. A simulation experiment was conducted by applying a 30% reduction of subsidy to the electricity sector. This policy shock was applied to the model in two scenarios. In scenario 1, the subsidy reduction was applied and results were compared with the baseline scenario given in the SAM. This yielded adverse economic effects on most endogenous variables but positive environmental benefits in terms of CO2 emission reduction. Electricity tariff increased by three-fold from 2 to 6 fils (0.7 cents to 2 cents) per kWh. GDP fell by 0.5% and aggregate household welfare declined by 0.8%. In scenario 2, subsidy reduction was accompanied with cash transfers to compensate user losses. The subsidy deducted from the electricity sector was allocated to users according to their share in base year total expenditure on electricity. The results indicated that such transfers would reduce the adverse economic effects, CO2 emissions fell by 0.5%. The GDP and household welfare effects were reversed, rising by 0.4% and 0.1% respectively.