The economics of takings.

Somin, Ilya

The Economic Theory of Eminent Domain: Private Property, Public Use

By Thomas Miceli

214 pages; Cambridge University Press, 2011

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The Supreme Court's controversial 2005 decision in Kelo v. City of New London led to massive public controversy over an issue that previously had been of interest mostly to economists and legal scholars: the government's use of eminent domain to take private property and transfer it to other private parties. Kelo ruled that the Public Use Clause of the Fifth Amendment allowed the government to condemn property for transfer to private parties in order to promote "economic development." It concluded that virtually any claimed public benefit satisfies the constitutional requirement that eminent domain can only be employed for a "public use." In the aftermath of Kelo, polls revealed that some 80 percent of the public opposed the ruling, and 44 states passed eminent domain reform legislation.

Much of the debate over Kelo has focused on legal issues: whether the Supreme Court correctly interpreted the U.S. Constitution. But there are also important economic policy issues at stake. Do we really need private-to-private takings in order to facilitate economic growth and provide other public benefits, or do such condemnations generally do more harm than good? Kelo has also rekindled debate over other questions that were not directly involved in the case, such as the amount of compensation that government should pay to property owners whose land is condemned, and whether or not the state should be required to compensate owners for "regulatory takings"--situations where government regulations restrict property owners' rights without formally taking title to the land and usually without physically occupying it.

Thomas J. Miceli's The Economic Theory of Eminent Domain is one of the best and most thorough analyses of the economics of takings to date. It covers not only the public use questions directly addressed in Kelo, but also the related compensation and regulatory takings questions. The book will be of great value to economists, legal scholars, policymakers, and others interested in eminent domain.

At the same time, the book does sometimes underrate the dangers posed by the ability of government to use eminent domain for the benefit of influential private interests. Miceli also occasionally seems to overestimate the ability of judges to make complex economic judgments about the efficiency of various government policies.

Public use and holdouts | Miceli devotes the first part of the book to the problem the Supreme Court considered in Kelo: When should the government be allowed to condemn private property? He argues convincingly that the use of eminent domain is only likely to be economically efficient in cases where there are "holdout" problems: situations where one or a small number of individual property owners who refuse to sell to a developer might block a project whose value exceeds that of the current uses of the land. In such cases, the market might fail to produce an efficient outcome because developers are unable to assemble the land they need.

For example, consider a situation in which a developer needs to acquire five square miles of land to build a factory that is worth $1 million more than the current uses of the property. But the land is currently divided up between 1,000 owners. If the developer tries to purchase the 1,000 parcels piecemeal, one or more of the owners might try to take advantage of the situation by asking for an exorbitant price, such as 90 percent of the expected value of the project. If even a few of the current owners try to hold out in this way, the project is likely to be scuttled, since the developer would end up paying more for the land than the expected profit. Like many other scholars, Miceli concludes that eminent domain is needed to overcome such holdouts.

On the other hand, Miceli effectively argues that eminent domain is not justified in most other situations. Many local governments and other defenders of the Kelo decision contend that eminent domain can be justified any time the new use of the condemned property might contribute to the local economy. But, absent holdout problems, private sector transactions should be able to achieve the most economically efficient uses of the land as well or better than the state. A developer who has a more productive use for a piece of land than the current owners can simply purchase it from them.

Some economists and legal scholars claim that eminent domain is also needed in order to produce public goods that might be underproduced by the market. But, as Miceli explains, subsidies for development or tax incentives can achieve the same goal and are less intrusive and coercive than eminent domain.

Miceli's holdout theory does have some shortcomings of its own. As he recognizes, the private sector has various mechanisms of overcoming holdout issues without resorting to eminent domain. The best-known is secret assembly, under which developers purchase the land they need from the current owners without letting them know that they are planning a large scale development project. This is how the Disney Corp. was able to assemble the land for Walt Disney World, for example. In addition, even if a holdout problem is present, a proposed development project might still not be as valuable as the current uses of the condemned property. The taking could simply be the result of lobbying by powerful interest groups, such as a major corporation or influential developers. The Kelo taking itself was in part the result of lobbying by Pfizer Corp., a major pharmaceutical firm, which hoped to benefit from the condemnation. Interest group power also played a key role in the most famous pre-Kelo economic development taking: the 1981 Poletown case. Some 4,000 people in a Detroit neighborhood were forced out of their homes in order to transfer their property to General Motors so that the latter could build a new factory. In both cases, the measurable economic costs of the taking far outstripped the benefits, even discounting the psychological harm inflicted on homeowners.

Because of considerations like these, Miceli ultimately argues for "a balanced approach to public use under which courts would treat the holdout problem as a necessary, but not a sufficient, condition for extending the power of eminent domain to private parties" (p. 153). Unfortunately, he does not explain how the different factors should be weighed against each other. How can judges tell whether a given holdout really requires the use of eminent domain to overcome it?

Moreover, it is far from clear that judges have the specialized knowledge necessary to sort out cases where there are genuine holdout problems from those where the fear of holdouts is merely a pretext for a taking sought by influential interest groups. Similarly, judges might have difficulty telling the difference between owners who refuse to sell because they are trying to be strategic holdouts from those who refuse because they genuinely value the land more than the would-be developer does. If the latter is the case, using eminent domain is ill-advised even from the standpoint of policymakers whose only interest is economic efficiency, It is inefficient to forcibly transfer land from owners who value it more to those who value it less.

In some instances, Miceli also underrates the social costs inflicted by takings. For example, he argues that the use of eminent domain for purposes of "urban renewal" should be permitted because, otherwise, holdout problems might prevent the revitalization of depressed urban neighborhoods. However, the actual record of urban renewal takings is extremely dubious. Since World War II, hundreds of thousands of people have been forcibly displaced by such condemnations, inflicting tremendous harm on them, often for little or no economic gain. Urban renewal takings might be justified, in some cases, as a matter of economic theory. But the incentives of real-world governments led them to be used far more widely than any economic logic would justify.

Compensation | After the discussion of public use, Miceli considers the longstanding debate over the amount of compensation that should be provided to property owners whose land is condemned. Current legal doctrine interprets the Fifth Amendment's mandate of "just compensation" for takings as requiring the government to pay the "fair market value" of condemned property. However, some economists argue that the best policy is to pay zero compensation because, otherwise, landowners might overinvest in their land. Owners might discount the risk of condemnation if their losses are fully compensated by the government.

On the other hand, an opposing group of commentators fears that the zero compensation would lead to excessive condemnations because government bodies would not consider the costs that condemnation inflicts on property owners if governments did not have to pay for them. Miceli suggests that both arguments have some merit, which leaves him at something of an impasse. He notes that it is possible to square this circle through tax assessment policy, which in theory could compensate owners at exactly the right levels to optimize their incentives. However, this is only feasible under theoretical conditions that are unlikely to occur in the real world, such as a "benevolent" government that seeks only to maximize economic efficiency.

In my view, both Miceli and much previous literature overstate the zero compensation argument. Even if full compensation leads property owners to overinvest because they discount the possibility of a taking, the resulting inefficiency is likely to be small because most properties have a very low probability of being targeted for takings. In addition, if Miceli's analysis in the first part of the book is correct, the use of eminent domain by government should be strictly limited, which would further lower the risk of condemnation. The problem can also be at least partly mitigated by simply discounting the level of compensation slightly by a percentage equal to the likelihood of condemnation. That way, owners will diminish their investments at the margin to a degree that incorporates condemnation risk. This simple solution is unlikely to be perfect, but would take a bite out of an already modest problem.

In the real world, excessively high compensation is less common than the opposite. Miceli reviews recent empirical research suggesting that most owners of condemned property do not actually receive the fair market value compensation required by law. A comparatively fortunate few get more than fair market value, but a larger percentage gets less. Local governments can get away with lowballing owners who lack legal sophistication or simply do not have the time and money to fight it out in court.

Like many previous scholars, Miceli recognizes that even if owners succeed in getting fair market value compensation, they may not be fully compensated for their losses because many owners also attach a "subjective value" to their land over and above its market price. If they valued the property at its market value or less, they would likely have sold it on the open market even before the government sought to condemn it. The book provides a careful review of the various creative schemes economists and legal scholars have come up with to try to induce owners to reveal their true valuations and enable government to come up with a more accurate compensation formula. Miceli concludes that these ideas are largely impractical and unlikely to be implemented successfully. Ultimately, the difficulty of coming up with an accurate and efficient formula for measuring compensation is an additional argument for constraining the use of eminent domain in the first place.

In one of very few questionable conclusions in this part of the book, Miceli suggests that the problem of public use is only important because of inadequate compensation. If we could fully compensate the owners of condemned property, they would, presumably, have no reason to object to the loss of their rights.

But public use restrictions on takings might still have merit even if property owners are fully compensated, indeed even if they actually gain more from takings than they lose. The owners are not the only victims of ill-advised takings like Poletown and Kelo. The community at large also suffers because of the expenditure of public resources and the destruction of existing land uses that are often replaced with less valuable ones. Indeed, the higher the compensation payments to owners, the greater the loss to the taxpayers. As with many other constitutional rights, Fifth Amendment protections for property rights benefit more than just those who exercise these rights directly. The First Amendment right to free speech, for example, not only protects individual speakers but also helps the rest of society by ensuring open debate on political issues. Similarly, the Public Use Clause protects the general public as well as individual property owners.

Regulatory takings | The last part of Miceli's book addresses the difficult problem of regulatory takings, cases where government regulations restrict owners' options and reduce the value of their property without actually taking over title. Advocates of a robust regulatory takings doctrine argue that the concept should be defined broadly in order to protect property owners and reduce harmful regulations. Opponents claim that requiring compensation would deter government from implementing beneficial regulations.

Miceli seeks to cut through this longstanding debate by proposing that compensation should be required when the regulation at issue is economically inefficient, but not when it is efficient-in the sense that it creates more economic value than it destroys. On the level of abstract economic theory, it is hard to quarrel with this view. Who could be in favor of inefficient regulations or against efficient ones? In practice, unfortunately, Miceli's proposal runs into serious problems. The most obvious is the enormous informational burden it imposes on courts. How are judges to determine whether a regulation is efficient or not? Most judges lack expertise in economics and regulatory policy. Even those that do have such knowledge might still lack the information necessary to evaluate a specific regulation. For the same reasons that the "subjective value" of property is difficult to estimate in the context of compensation payments, it is also often difficult or impossible to gauge the true costs of regulations that restrict land uses.

To his credit, Miceli anticipates this objection. He suggests that it is overstated because courts often make similar judgments in tort cases when determining what qualifies as negligent behavior. However, evaluating the efficiency of a regulatory regime that restricts thousands of landowners is a far more difficult task than evaluating the risks posed by a single individual's or firm's discrete decision-the sorts of questions decided by courts in most run-of-the-mill tort cases. When tort suits do address broad policy questions-as in mass tort cases involving the production practices of major industries-the judiciary's work has come in for heavy criticism by economists and legal scholars.

It would be a mistake to reject Miceli's idea out of hand. But the theory would be more persuasive if it were coupled with a better explanation of how courts can engage in the task of judging efficiency.

Miceli's argument also runs into an important legal and moral objection. The U.S. Constitution requires "just compensation" for all takings, not just inefficient ones. As a matter of distributional fairness, we may want to compensate property owners even for efficient restrictions of their property, so that the cost of regulations that benefit the entire community will not be imposed arbitrarily on one small group.

Conclusion | Miceli's Economic Theory of Eminent Domain is an excellent account of the major issues in its field and is likely to become a standard reference for scholars. But not all of its arguments are fully convincing. The debate over eminent domain that heated up after Kelo is likely to continue.

ILYA SOMIN is associate professor of law at George Mason University School of Law and co-editor of the Supreme Court Economic Review He is writing a book on the Kelo case and its aftermath. He blogs regularly at the Volokh Conspiracy, www.volokh.com.