The Role of Government in Addressing Market Failure Through Tax and Subsidy Policies

Abstract

Market failure arises when market prices do not fully reflect social costs and benefits, producing inefficient resource allocation. This study examined how government taxation and subsidy policies address market failure, particularly environmental externalities and implementation challenges relevant to Indonesia. A qualitative descriptive literature review examined selected scholarly publications through conceptual identification, thematic classification, and comparative synthesis. The analysis distinguished negative externalities, underprovided socially beneficial activities, fiscal instrument mechanisms, and institutional constraints. Findings indicated that corrective taxes can internalize external damages by increasing the private costs of harmful activities, while targeted subsidies can encourage socially beneficial investments and services. Carbon taxation and motor vehicle fuel levies illustrated environmental applications, whereas agricultural support and clean technology incentives demonstrated alternative subsidy mechanisms. Policy effectiveness depended on appropriate instrument calibration, beneficiary targeting, administrative capacity, fiscal feasibility, and consideration of distributional consequences. Taxes may impose disproportionate burdens on vulnerable households, while poorly targeted subsidies can generate additional distortions and budgetary costs. The review developed a five-stage conceptual evaluation framework covering market failure diagnosis, instrument selection, welfare assessment, institutional feasibility, and policy monitoring. Its contribution is comparative rather than empirical; future research should test policy outcomes using reliable observed behavioral, fiscal, distributional, and environmental outcome indicators