Abstract
The Supreme Court’s ruling in Kelo v. New London (2005) justified the use of eminent domain for redevelopment takings based on the anticipated spillover benefits to the community in the form of increased taxes and new jobs. This paper asks whether this is a coherent economic rationale for allowing expropriation of residential land for private development. We show that, in the absence of a market distortion, the answer is generally no. However, when there is a pre-existing imperfection in the land and/or labor market, it is possible, though not guaranteed, that allowing eminent domain will increase social welfare. The reason, however, is not because of the increased tax revenue or employment per se, but rather because eminent domain increases industrial/commercial land use above the inefficiently low level that arises in the presence of the distortions. Thus, setting aside questions about fairness or holdouts, we show that whether using eminent domain for private takings can be justified on the basis of economic efficiency hinges on the existence of market distortions and the relative values of residential vs. industrial/commercial land in that particular market.
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Notes
545 U.S. 469 (2005).
See, for example, Epstein (1985, p. 166), who observes that “the language of public use invites the theory of public goods.”
Kelo (2005), pp. 483–484.
See Berman v. Parker, 348 U.S. 26 (1954), and Poletown Neighborhood Council v. City of Detroit, 304 N.W.2d 455 (Mich. 1981). In 2004, however, the Michigan Supreme Court reverse its earlier ruling in Poletown in County of Wayne v. Hathcock, 684 N.W.2d 765 (2004).
But see Kelly (2006), who argues that private developers can use secret buying agents to overcome holdouts, a strategy that is generally unavailable to the government.
We make this assumption to simplify the graphs below. All of our analysis carries over (with appropriate notational changes) to the case where initially some land is in industrial use.
We ignore zoning restrictions, or assume that the local government makes the necessary changes, so that there is no regulatory constraint on converting land from one use to another. In addition, in this section we do not explicitly consider other inputs, such as capital and labor, that might be needed for the project. They are subsumed in the project’s value, which should be interpreted as a net value. In Section 3, we explicitly consider these other inputs.
Since we are not concerned with land assembly here, under this interpretation we are essentially assuming that the developer can freely vary the size of the project and that parcels are acquired in decreasing order of value.
Assume, for example, that the return to each project is \( \overline{V}-\beta \), where β ∈ [0, B] is a cost that varies across projects. A developer with a type-β project will then demand industrial land if and only if \( \overline{V}-\beta \ge P \). This defines a range of β over which projects will be profitable, given by \( \left[0,\overline{V}-P\right] \). Thus, total demand for industrial land is given by \( Q(P)=\underset{0}{\overset{\overline{V}-P}{\int }}N\cdotp f\left(\beta \right) d\beta \), where N is the total number of potential projects and f(β) is the density function for β. Inverting this gives a demand function V(Q), where V ' (Q) < 0.
This assumption simplifies the discussion but does not change our fundamental results.
Courts have not generally allowed sellers to share in any surplus value created by the proposed development plan. Thus, any increase in the market value of the parcels owing to the prospect of the impending project would not be compensable. For example, if the buyer is able to arrange any consensual sales before resorting to eminent domain as described above, the resulting prices, if greater than PM, would not be a basis for compensation.
Note that as t → 0, the efficiency loss from the market outcome approaches zero, but the efficiency loss from the use of eminent domain does not, since under-compensation (and hence a subsidy to industrial land use) still exists. Thus, the smaller the property tax rate, the more likely it is that using eminent domain for private takings reduces efficiency even if it increases local tax revenue.
We ignore any externalities that the productive activity might generate. If present, this would result in excessive industrial land, all else equal.
This marginal benefit for each worker hired is taken to be constant, reflecting the set wage of w and the fixed opportunity cost μ. More generally, μ would be increasing in the level of employment, reflecting an upward sloping supply of labor curve. The assumption of a constant μ is reasonable if this city is a small part of the overall labor market.
Consistent with the analysis above, as w → μ, the labor market distortion goes to zero but the distortion from under-compensation does not. Thus, the closer w is to μ, the more likely it is that the use of eminent domain will be welfare-reducing, even though it leads to additional jobs.
Michelman (1967) actually introduced this concept in his analysis of uncompensated regulations, but the same cost would presumably apply to any non-consensual expropriations that involve unwilling sellers, especially when the entire parcel is taken rather than merely being regulated. Indeed, one might suppose that demoralization costs would be increasing in the magnitude of the victim’s loss, regardless of the specific nature of the action.
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Acknowledgements
We appreciate the comments of Austin Jaffe, Katherine Pancak, C.F. Srimans, Geoffrey Turnbull, and participants at the “Critical Issues in Real Estate” Symposium, sponsored by Florida State Univ., Univ. of Florida, and Univ. of Central Florida, March 22-24, 2018.
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Miceli, T.J., Segerson, K. Assessing Kelo’s Legacy: Do Increased Taxes and New Jobs Justify Use of Eminent Domain?. J Real Estate Finan Econ 63, 161–176 (2021). https://doi.org/10.1007/s11146-020-09772-7
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DOI: https://doi.org/10.1007/s11146-020-09772-7