Taking compensation private.

• Author: Bell, Abraham

INTRODUCTION I. THEORETIC JUSTIFICATIONS FOR JUST COMPENSATION A. Fairness-Based Justifications B. Efficiency-Based Justifications C. Public Choice and Interest Group Payoffs II. THE FLAWS IN MARKET COMPENSATION A. Surplus Subjective Value and Goodwill B. Community Premiums C. Bargaining, Litigation, and Transaction Costs III. A SELF-ASSESSMENT MODEL OF EMINENT DOMAIN COMPENSATION A. An Alternative Proposal B. Assessing Self-Assessment IV. POTENTIAL OBJECTIONS A. Government Abuse B. Corner Cases C. Changed Circumstances D. Gaming the System E. What's Left of Eminent Domain? CONCLUSION INTRODUCTION

Eminent domain is a controversial prerogative, and an obvious challenge to vital private property rights. It is not surprising, therefore, that this power has sparked a great deal of public interest and scholarly debate. The Takings Clause of the Fifth Amendment places two restrictions on the power of the government to take private property. First, taken property must be put to public use. Second, just compensation must be paid to aggrieved property owners. The public use requirement has gradually been rendered virtually non-existent in light of the Supreme Court's rulings in Hawaii Housing Authority v. Midkiff and then in Kelo v. City of New London that the public use clause is conterminous with the government police powers. (1) Consequently, "just compensation" remains the only meaningful safeguard of private property rights and the only check on government abuse of its eminent domain power.

It is curious, therefore, that while public use continues to attract scholarly interest, very little attention has been paid as of late to the arguably more important requirement of "just compensation." (2) As it currently stands, the law of eminent domain compensation suffers from two principal flaws. First, although the Takings Clause requires, in principle, the payment of compensation for the full loss occasioned on property owners, (3) in practice, current law settles for the payment of the market value of the property taken--a benchmark that often falls far short of the reserve price of the aggrieved owner. (4) Thus, takings law permits undercompensation whenever the reserve value of the property owner exceeds market price. Second, many important compensation doctrines require courts specifically to ignore different kinds of value lost to owners of taken property, such as goodwill. (5)

The problem of inadequate compensation has not gone unnoticed by courts. (6) Judge Posner wrote in Coniston Corp. v. Village of Hoffman Estates:

Compensation in the constitutional sense is ... not full compensation, for market value is not the value that every owner of property attaches to his property but merely the value that the marginal owner attaches to his property. Many owners are "intramarginal," meaning that because of relocation costs, sentimental attachments, or the special suitability of the property for their particular (perhaps idiosyncratic) needs, they value their property at more than its market value.... (7) Undercompensation is both unfair and inefficient. It is unfair because it deprives property owners of part of the value of the property taken. As Justice Black famously stated in Armstrong v. United States, "The Fifth Amendment's [just compensation] guarantee ... was designed to bar Government from forcing some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole." (8) An award that falls short of full compensation potentially wrongs the condemnee. (9) As for efficiency, undercompensation may induce excessive takings because it allows the government to ignore part of the cost it imposes on private property owners through its land use policies. Theorists have pointed out that government decision making is subject to fiscal illusion, which prompts the government to believe that actions that do not affect the budget are, in fact, costless. (10) On this theory, partial compensation will lead the government to take too much. (11) Additionally, by failing to pay full compensation for its takings, the government incentivizes property owners to oppose potentially societally beneficial projects. (12)

It bears emphasis that eminent domain law has adopted fair market value as the compensation benchmark despite its tension with the goal of full compensation for purely practical reasons--that is, "[b]ecause of serious practical difficulties in assessing the worth an individual places on particular property at a given time...." (13) Subjective value is neither observable nor readily ascertainable by third parties; only the aggrieved property owners know the true value of their property. Yet, courts cannot rely on the testimonies of aggrieved property owners for fear that they would exaggerate the value they place on property in order to increase the compensation they receive. And courts have no reasonable means at their disposal for reviewing the accuracy of owners' self-serving reports. (14)

Moreover, more accurate compensation mechanisms would likely exacerbate the already considerable problems of high litigation and other transaction costs. Aggrieved owners often invest considerable resources in legal battles with the government in an effort to raise compensation awards. Regardless of the ultimate outcome, the negotiations and litigation that attend eminent domain exercises cost time and money both to private property owners and the government. Thus, the current compensation mechanism generates considerable efficiency losses without yielding meaningful offsetting benefits. (15)

Recognizing the inherent inefficiencies of the existing compensation regime, some scholars have proposed that compensation be withheld for certain small takings. (16) Others have doubted the wisdom of eminent domain power altogether. (17)

Indeed, it is difficult to devise a compensation mechanism that would lower transaction costs while simultaneously enhancing accuracy and ending undercompensation. The more we invest in determining the condemnee's subjective value, the costlier the compensation process. Conversely, compromising the accuracy of the compensation mechanism by eschewing payment for such items as goodwill lowers the cost of the process but only at the price of greater undercompensation of subjective value. (18)

In this Article, we introduce an innovative bargaining mechanism that can dramatically reduce the scope of both problems, and importantly, does so at a very small cost. At the core of our model lies a self-assessment apparatus that is designed to induce potential condemnees to accurately report the subjective value they place on the property to be taken. The basic version of the mechanism works as follows: at stage I, the government announces its intention to take property by eminent domain. Thereafter, at stage II, affected property owners name the price they want for their properties. Finally, at stage III, the government either proceeds with its plan and seizes the properties at the named price or abandons the proposed taking. If the government decides not to take property at the self-assessed price, the owner will retain title to the properties, but will become subject to two restrictions. First, for the life of the owner, the property cannot be sold for less than the self-assessed price. If the property is transferred for less than that price, the owner will have to pay the shortfall to the government. (19) Second, the self-assessed price will become the benchmark for the owner's property tax liability. As we will show, the combined effect of partial inalienability and enhanced tax liability should suffice to keep the owner honest in reporting her subjective value.

To see how the proposed mechanism would work, consider the following example. Imagine that the city of Chicago declares its desire to use its power of eminent domain to seize Blackacre, a property owned by the Epstein family. The property has an assessed value of $200,000 on the city property tax rolls and a market value of $300,000. (20) Assume, however, that the Epstein family values the property at $400,000 and names this amount as the price of realty for the purpose of the taking. If the City of Chicago decides to take the property, it will have to pay the Epsteins $400,000 in compensation. If, however, the city decides to forego the taking, the Epsteins will not be able to sell Blackacre for less than $400,000, and the property tax they have to pay will be based on the same figure. (21)

The virtues of the self-assessment mechanism are significant. It provides more accurate compensation for subjective value, while dramatically reducing transaction costs created by the compensatory process. Since owners name their price, they will state a value that is no less than their subjective value, as there is no reason for them to voluntarily part with their property for less than the full subjective value. However, owners will not state a price greater than the subjective value, lest they subject themselves to excessive tax liability and limitations on alienation. (22) Moreover, the mechanism is self-policing and therefore should reduce the costs of assessing and litigating property valuations. By relieving both sides of the need to hire expert assessors and legal counsel and to engage in extensive evidence collection, our proposal significantly lowers the transaction costs associated with compensation.

The basic model gives rise to one potential peril, however. The government may announce its intent to take properties by eminent domain simply to boost its tax revenues. To keep the government from strategically abusing its power, we complement the basic model with a "decoupling" mechanism that severs the amount paid by the owner for high self-assessed valuations and for redeeming a property's inalienability restriction from the amount collected by the government. We show that with this adjustment and...