Abstract Subsidizing energy has been widely used but is economically unfavorable. The Malaysian government has shown strong intention to reduce energy subsidies recently, but face challenges to prepare policy instruments to manage the impact. This study develops a Computable General Equilibrium (CGE) model with breakdown of households by income level to evaluate the potential impacts of removing energy subsidies on the Malaysian economy. It is shown that removing petroleum and gas subsidy would improve economic efficiency and increase GDP up to 0.65%. Budget deficit would be largely reduced after removing the petroleum subsidies, especially when the saved subsidy cost is not budgeted for other expenditure. Households would be worse off in most scenarios due to higher price level, but some compensation policy could make the lowest income group no worse than baseline, without harm the economy. The reduction in carbon emissions ranges 1.84–6.63% in different scenarios. The simulation results suggest Malaysia to completely remove all fuel subsidies and use the saved funding to cut budget deficit or spend on education, health and other service sector. It is also necessary to set a compensation scheme to minimize public resistance and make sure such scheme is affordable.