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[Nicole Garnett (guest-blogging), February 12, 2007 at 3:16pm] Trackbacks
What Undercompensation Problem?

Many thanks to Eugene for inviting me to blog about The Neglected Political Economy of Eminent Domain. As Eugene notes, I come to this subject with strong priors – I worked for the Institute for Justice (Susette Kelo’s attorneys), and I disagree with (although I was not surprised by) the holding in the Kelo case. In a previous article, I also used the undercompensation risk to justify strong public-use review. Thus, it is fair to say that I was surprised, upon further investigation, to reach the conclusion stated in the article—that legal scholars may overestimate the extent of the undercompensation problem.

I’ll divide my discussion into five posts. This first post explains why legal scholars assume that owners are undercompensated when their property is taken by eminent domain; it also argues that traditional discussions of eminent domain have been too court-centric, leading scholars to overlook the critical role that non-judicial government actors (“Takers”, if you will) play in the eminent domain process. On Tuesday, Wednesday, and Thursday, my posts will discuss three ways that “Takers” may minimize undercompensation. Finally, on Friday, I will explain why I believe that so-called “economic development takings” are problematic even if most owners receive above-market compensation.

The “Undercompensation Problem”

Scholarly concern about undercompensation flows from the fact that the constitutionally mandated measure of compensation in an eminent domain action — i.e, the property’s fair market value — can fail to indemnify owners fully. As Lee Fennell has helpfully described, the losses suffered by an owner whose property is taken by eminent domain may have both a “compensated increment” (the fair market value award) and an “uncompensated increment” (the owner’s losses exceeding that award). The "uncompensated increment" may be made up of any (or all) of the following losses:

Economic Losses: Fair-market-value compensation does not cover relocation expenses, good will associated with a business’s location; it may also fall short of replacement value. Eminent domain also deprives owners of the gains from trade that a market transaction might generate. The inability to say “no” unquestionably leaves many owners worse off than if they had freely negotiated a purchase price. (This is not surprising. After all, the need to avoid holdouts strategically seeking unjust gains from trade is a common justification for eminent domain.)

Subjective Losses: An owner may value her property more its market price. Cognitive psychologists and experimental economists have found that possession alone generates an “endowment effect” – i.e., individuals consistently demand more to part with an entitlement than they would be willing to pay for it in the first instance. While this “offer-ask” disparity only trivially affects most markets, it is greatest for episodic events such as an eminent domain action. Additionally, an owner’s sentimental attachment to her property - for example, the attachment resulting from the property's connection to family and community relationships - may widen this disparity between subjective- and market-value.

Dignitary Losses: Carol Rose has observed that “there is something about land that makes you think that when you own it, it is really, really yours.” Perhaps for this reason, targets of eminent domain may suffer what can be broadly categorized as “dignitary harms.” Owners may feel unsettled upon learning that the government plans to take their property. Expanding the scope of the takings power may increase all property owners’ feelings of vulnerability. As Justice O’Connor observed in Kelo, “The specter of condemnation hangs over all property. Nothing is to prevent the State from replacing any Motel 6 with a Ritz-Carlton, any home with a shopping mall, or any farm with a factory.”

Owners also may attach independent, non-instrumental significance to the economic autonomy that property guarantees. The loss of economic autonomy may be particularly upsetting in the economic development context, for at least two related reasons: First, owners may be offended by the government’s implicit suggestion that the current use of their property is less than socially optimal and that some other private owner would put it to a “better” use. Second, property owners may feel that the government has treated them unfairly vis-à-vis other owners. To borrow from Saul Levmore’s work in the regulatory takings context, every exercise of eminent domain “singles out” individual property owners to bear the cost of broader societal goals. The knowledge that the government could have advanced its plans by taking someone else’s property may leave property owners asking “why me”?

A Non-Court-Centric Approach to Understanding Eminent Domain

The possibility that property owners may be undercompensated in the eminent domain process is frequently cited in the literature discussing the public-use problem. Some commentators—including myself—cite the potential for undercompensation as one reason that judicial policing of the boundary between “public” and “private” takings is needed. Others—most recently Professors James Krier and Chrisopher Serkin—have explicitly suggested additional compensation as an alternative to judicial review of public-use claims. Most of the eminent domain literature, however, ignores the important role of non-judicial government actors (the people that I call “Takers”) in the eminent domain process. Understanding Takers’ role is important because judges play only a bit part in the eminent domain process. Takers, not judges, shape projects, identify the property needed to complete them, and negotiate with property owners prior to instituting formal eminent domain actions. Indeed, in the vast majority of cases, formal eminent domain proceedings are never commenced.

The universal disregard for how eminent domain works outside of the courtroom may have led previous commentators (again, including myself) to overstate the undercompensation problem. Takers operate under incentives that should minimize undercompensation: They need to avoid holdouts and the political fallout from negative publicity. They are legally obligated to bargain with property owners and penalized financially if these negotiations fail. And they almost always are legally required to provide substantial relocation assistance to displaced owners. While the evidence presented here is incomplete—further study is in order—my article represents an important first step toward understanding how Takers’ behavior shapes the nature and extent of the undercompensation problem.

Dilan Esper (mail) (www):
I can't stand Kelo at all, but it seems to me that when you have an actual public use and therefore a basis for the government to take property, you really have to stick with objective valuation, for the same reasons why the law sticks to objective valuation just about everywhere else (e.g., if someone negligently damages the vase your mother gave you as a wedding gift, you recover the replacement value of the vase, not the sentimental value that the particular vase had to you). Subjective valuation is subject both to a reasonableness objection and proof problems. The reasonableness objection is that many subjective valuations may be honestly held but completely unreasonable (and thus beyond what the government or a tortfeasor should have to pay for taking your property). The proof problems arise from the fact that a compensation system based on subjective valuation creates a great incentive for those seeking compensation to lie or overstate how much they value the property. (The same objections can be lodged against the dignitary harms, although one could come up with an objective amount of standardized compensation for dignitary harm, say, when a homeowner's sole residence is taken.)

This is why law and economics has to move towards wealth-maximization rather than utility maximization. There's no way the legal system can work without dollarizing everything in a reasonably objective manner.

That said, I agree that this is a good reason to police the private-public use distinction. Where there is no valid public purpose, running the risk of uncompensable subjective and dignitary harms seems inexcusable.
2.12.2007 4:44pm
EconC:
The simple fact that current property owners do not sell at the going market price implies that their valuation of the property is higher than the current market price.

This is the underlying idea behind consumer surplus, and forcing owners to sell at market price means that only the marginal property owners will be indifferent between the compensation and retention of the property.

On the other hand, the high transaction costs of selling property may mean that many owners value their land less than the market price, but more than the market price minus the cost of hiring a real estate agent, etc. The costs of transacting in property are clearly important in all of these analyses and I wonder whether they are being considered by the policy makers and researchers.
2.12.2007 5:09pm
New World Dan (www):
Well, if you assume that "everyone has their price", then intrinsicly, any eminent domain siezure is undercompensating. Furthermore, if you need my land to complete your project, then basic economic sense indicates that my property should be far more valuable than it would be absent your need. Then, there is also the degree of substatuitability; You might only have 1 or 2 viable routes to locate your road, but maybe half a dozen places to put your shopping center. So, suppose you negotiate purchase agreements with 95% of the land owners for what you need to take, at that point, you have a pretty good objective benchmark for determining compensation for the few holdouts.

I'm rambling here, but I would expect that in most cases, it's possible to negotiate with the vast majority of landowners. And as Dilan Esper has suggested, objective standards are very important. For a given siezure, a government should have sales options/contracts with XX% of land owners (in terms of area, appraised value, and maybe even number of distinct land owners). I also support having a jury (not a judge) determine if a taking is legitimate.
2.12.2007 5:42pm
Dan Hamilton:
I purchase land and a house on a river or lake that I wish to live at. I bought the land when nothing was close and it was reasonable. Now the town has moved around me. The Government now wants my land to give to some developer. They say that my land and house has a market value of X but there is no way that I can buy property on a river or lake for 2X.

Who decides what is the market value? The house across the street they value at X the same as my house and land on the river. The developer wants the land BECAUSE it is on the river or lake. Yet the market price is no where near the replacement value for my LOCATION.

There can be any number of location based reasons that I purchased the property. Now because the property is wanted by some developer who likes the Location and I am not willing to sell the Government is going to force me to take some price for a house and land that cannot be replaced for anything near what they are giving me.

The supposed fair market value seldom really takes into account the location. Let alone the cost of purchasing a place in a similar location anywhere near the original location. The HOUSE can be cheap the location priceless.

If the Government is building a school, or something else like that then that is different then if the government is forcing me to sell so that a Johnny come lately developer can get my land.

As is always said Location, Location, Location. I got there first, bought the land, and some developer now wants it. To (&(*^*%&$#(* bad.

just a house somewhere that is a common no real problem. The fair market value can work. But on a great location, forget it.
2.12.2007 6:16pm
Jake (Guest):
Assuming we're dealing with a politician who only cares about getting reelected (but I repeat myself), does he even have an incentive to bargain hard for a reduced price? It seems like all he would care about is getting the deal done at a price not sufficiently outrageous as to arouse taxpayer ire. Maybe if the project involved a lot of parcels you would worry about small overpayments accruing into something noticeable.
2.12.2007 6:16pm
Brett Bellmore:
There's no such thing as objective valuation, value is subjective. And there's no such thing as a market value in the absence of a willing seller, since the true market value of a thing is the price that would be arrived at in a <i>voluntary</i> transaction. "The price an unwilling seller would sell at if they were willing to sell" is a nonsensical concept.

As I drive down a freeway on land assembled by eminent domain, and note the median you could build a subdivision in, (Or at least a line of strip malls!) and parkland on either side larger than most of the parcels that were condemned to build it, I am persuaded that the chief value of eminent domain to government is not that it makes public works <i>possible</i>, but that it makes it possible for the government to build them without having to make any of those inconvenient tradeoffs that characterize private sector developments. It makes things too <i>easy</i>.
2.12.2007 6:19pm
msmith (mail):
Interesting, hope your article will help shed some badly needed light on actual eminent domain practise and procedure, after the near-hysteria that followed Kelo.

In Arizona, Prop 207 was offered up after "the people of Arizona" had declared certain things. I just include the comical definitions of "Fair Market Value" and "Just Compensation". Good luck in trying to introduce some reason and sense into the public discussion post-Kelo.

Arizona's Prop 207
B. Having made the above findings, the people of Arizona declare that all property rights are fundamental rights and that all people have inalienable rights including the right to acquire, possess, control and protect property. Therefore the citizens of the State of Arizona hereby adopt the Private Property Rights Protection Act to ensure that Arizona citizens do not lose their home or property or lose the value of their home or property without just compensation. Whenever state and local governments take or diminish the value of private property, it is the intent of this act that the owner will receive just compensation, either by negotiation or by an efficient and fair judicial process.

Sec. 3. Title 12, chapter 8, Arizona Revised Statutes, is amended by adding article 2.1, to read (in part)

12-1136. DEFINITIONS

IN THIS ARTICLE, UNLESS THE CONTEXT OTHERWISE REQUIRES:

1. "FAIR MARKET VALUE" MEANS THE MOST LIKELY PRICE ESTIMATED IN TERMS OF MONEY WHICH THE LAND WOULD BRING IF EXPOSED FOR SALE IN THE OPEN MARKET, WITH REASONABLE TIME ALLOWED IN WHICH TO FIND A PURCHASER, BUYING WITH KNOWLEDGE OF ALL THE USES AND PURPOSES TO WHICH IT IS ADAPTED AND FOR WHICH IT IS CAPABLE.

2. "JUST COMPENSATION" FOR PURPOSES OF AN ACTION FOR DIMINUTION IN VALUE MEANS THE SUM OF MONEY THAT IS EQUAL TO THE REDUCTION IN FAIR MARKET VALUE OF THE PROPERTY RESULTING FROM THE ENACTMENT OF THE LAND USE LAW AS OF THE DATE OF ENACTMENT OF THE LAND USE LAW.
2.12.2007 6:55pm
Ron Hardin (mail) (www):
If the developer can make money on the land, there's no reason he shouldn't have to share that surplus with the landowner. Problem solved. With the government taking for public use, it's another matter, as no money is made.

As to the owner's higher valuation of the land than the market price, that's true, but he can take the money and find a similar parcel he also values at more than the price, is the theory, so that excess valuation argument falls short. Disagreement about value is what makes an economy possible
2.12.2007 8:05pm
Gideon Kanner (mail):
See my comments following Eugene's blog on this subject, dated Feb. 12, 2007.
To this I should add that in the vast majority of cases, where the spread between the offer and the fair market value (remember that the FMV as defined by courts is CONCEDEDLY deficient) is modest, the owners enjoy the status of fish in a barrel because the cost of hiring lawyers and appraisers, and other experts, will likely consume or seriously erode the potential recovery over and above the offer. These days, it takes mid- to high-five figures at least to litigate a small case (more if it's a partial taking case or if it involves issues of highest and best use, etc.) and most states do not allow recovery of attorneys' or appraisers' fees, or other litigation expenses (other than taxable court costs). You can take it from there.
2.12.2007 8:46pm
Dr. T (mail) (www):
Eminent domain should be a last resort when there is a true public need for the property and the owner refuses to sell at any reasonable price. At that point, the government should take the property but give the owner twice the fair market value. The government's true need will be "proved" by the high payment, and the owner will receive a more just compensation that helps cover the "intangibles" discussed above.
2.12.2007 8:54pm
advisory opinion:

At that point, the government should take the property but give the owner twice the fair market value.


Yes but that would encourage everyone else to hold out in the hope of getting twice the market value, defeating the purpose altogether!
2.12.2007 9:25pm
American Psikhushka (mail) (www):
Sheesh, it's a good thing we are talking about real property here and not people or their parts. It's a good thing those are protected by the Constitution, state, federal, and international law. Politicians and bureaucrats will try to steal or control anything that they can.
2.12.2007 9:36pm
lucia (mail) (www):
I don't think making the government pay twice fair market value is quite right. However, I think the government ought to pay full market value plus at least some reasonable relocation costs. Ordinarily, people sell and move when they have some reason to sell and move. In that case it makes sense that they bear the burden of moving all their own stuff because they are making the move for their own sake.

When the government seizes property, the person or entity who is forcing the move ought to pay these things. An extra $2k to $10K to move a whole families' belongings including beds, pianos, sofas, dining tables. (The exact amount would vary, but it's really not that cheap to hire people to move stuff.)
2.12.2007 10:32pm
Malvolio:
Yes but that would encourage everyone else to hold out in the hope of getting twice the market value, defeating the purpose altogether!
Why doesn't every seller hold out in the hope of getting twice -- or ten times -- the market value? Because they will lose the sale.

Presumably, if it is not worth 2x to the condemning government, they will simply not purchase the property. If it is worth 2x, why shouldn't the property owner be compensated at that level?
2.12.2007 11:13pm
A. Zarkov (mail):
In Michael Crichton's latest novel Next a biotech company buys a patient's cancer fighting cells from UCLA. When the biotech company loses the cell line from its inventory, the company gets a court to order the patient surrender more cells under, yes, the theory of eminent domain. The patient disappears and the company attempts to take cells from his daughter or grandson. The story was obviously motivated by Moore v. Regents of the University of California (51 Cal. 3d 120; 271 Cal. Rptr. 146; 793 P.2d 479 (1990). The California Supreme Court decided that Moore had no rights to his cells that were taken from him under false representations for the enrichment of the Regents and Dr. Golde.

Now that the concept of "property" has been expanded to include patented genes and cell lines (see US patent 4,438,032 for example), not only is your land at risk, but your very body. I should think one day the government will seize someone's kidney for the benefit of some "important person." Sound far fetched? Not really. Courts have already permitted organ harvesting from the incompetent (this includes the very young) to satisfy the needs of third parties under the dubious theory that the donor (although forced) benefits psychologically. See Strunk v. Strunk 445 S.W.2d 145 (Ky.1969) and Hart v. Brown, 289 386, 391 (Conn. Super Ct. 1972. The book Black Markets: The Supply and Demand of Body Parts by Michele Goodwin makes interesting reading on this subject.
2.13.2007 3:16am
Hans Gruber:
"In Michael Crichton's latest novel Next a biotech company buys a patient's cancer fighting cells from UCLA."

Forgive the off topic response, but would you (or any other commenter who has read it) recommend this book? I was debating picking it up.
2.13.2007 4:16am
A. Zarkov (mail):
"Forgive the off topic response, but would you (or any other commenter who has read it) recommend this book? I was debating picking it up."

I do recommend the book, and I enjoyed the audio version, which you can get from Itunes or Audible. However many reviewers over at Amazon complain the story is too convoluted, the character development is thin, and the narrative becomes tiresomely preachy. I disagree because I regard the story more as a precautionary tale than literature. You'll learn a lot about genetics, and biotech. Next motivated me to buy a few books dealing with genetics such as Genome. I personally enjoyed the barbs Crichton threw at the University of California, the media, divorce lawyers, arrogant scientists, government bureaucrats and rapacious venture capitalists. It's all a matter of taste. In my opinion Next is better than his prior book State of Fear, but I enjoyed that too. I guess I'm just a Crichton fan.
2.13.2007 5:18am
American Psikhushka (mail) (www):
A. Zarkov-

Scary stuff. One would think that more intrusive forms of abuse are prevented by the criminal law, tort law, and the like. I mean its not like a local government could "condemn" a person and use them for nonconsensual medical research, organ harvesting, and other exploitation without exposing themselves to massive criminal and civil liability.
2.13.2007 6:58am
hilmar:
There's also the problem of agriculture where the business IS the land. The government is only interested in the land but without the land there is no business. POOF -- the business income and value is reduced to nothing. Some agriculture is mobile but if you have orchards or vinyards then you can't take it with you.
2.13.2007 11:28am
Alfalfa Male:
I'm a real estate attorney. For two years, I worked with another attorney specializing in tax certificate properties. We acquired a large portfolio of low-grade residential properties. We found that receiving an eminent domain notice was cause for celebration because the government would always offer us more than we could have sold the property for.

On the other hand, I have a friend who bought a diner located on a highway that has a lot of truck traffic. The diner had two highway access points, so large trucks could easily enter and exit. This resulted in a large customer base consisting of truckers. The state highway department then took a sliver of the property to widen the shoulder. They also closed off one of the highway access points (even though it was not necessary to do so). The state paid my friend a small sum based on an appraised per square foot price based on the value of the surrounding properties. They did NOT take into account the revenue of the diner or the loss of income due to the loss of the entry point off of the highway. The diner lost so many customers that it had to close. Today, it sits vacant, an eyesore along the highway.
2.13.2007 11:52am
Dick Schweitzer (mail):
The focus of the Garnett blog seems to intend to concentrate on owners being "uncompensated," and goes on to frame that focus in terms of "Losses." But a premise is given that demonstrates how a false frame has shaped that focus. The blog stated:

"Scholarly concern about undercompensation flows from the fact that the constitutionally mandated measure of compensation in an eminent domain action — i.e, the property's fair market value — can fail to indemnify owners fully. As Lee Fennell has helpfully described, the losses suffered by an owner whose property is taken by eminent domain may have both a "compensated increment" (the fair market value award) and an "uncompensated increment" (the owner's losses exceeding that award)." - emphasis added

That is not what the Constitution says in Amendment V; rather, it provides that due process is required to deprive a person of property, and that when taken for public purpose, there must be -just-compensation.
Judicial gloss may have enobled Fair Market Value [FMV] as "just," but FMV is certainly not constitutionally mandated.
Whether or not FMV is just in any particular case is an issue of fact, not law.
Leaving aside the issues of "public purpose" vel non, we have ample examples in our jurisprudence of factual determination of "just," by simply regarding such events, intentionally caused, as giving rise to injuries, and that those injuries require determination of damages for compensation - just compensation. Much of what has been cited as "losses" could be evaluated better as injuries. In doing so, we will find ourselves back at the point where FMV awards are not always "just" compensation. That is the real issue, not "undercompensation."
s24rrs@aol.com
2.13.2007 5:05pm