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Eminent Domain (at a Price)

Saturday, December 18, 2010

The solution to the abuse of the eminent domain process is not endless legal inquiries or other ways to enrich lawyers. The answer is money.

My reputation—well deserved—is that of a property rights hawk. Nonetheless, I am impatient with the latest dispute over the Takings Clause, which concerns the Supreme Court’s denial of cert in Tuck-It-Away, the dispute over Columbia University’s campaign to take over large swathes of Manhattanville in New York City, which is the latest case in the Kelo line of eminent domain flare-ups.

George Mason University Professor Ilya Somin calls this case “a particularly egregious instance of the abuse of ‘blight’ condemnations to take property that was not blighted in any meaningful sense and transfer it to a powerful private interest group.”

That may well be true. The reason for my impatience, however, is that many problems could be alleviated by shifting attention away from doctrinal disputes over the nature of public use and toward the part of eminent domain doctrine that requires making “just compensation.” Raising the required compensation to a level that reflects the benefits of the deal to the acquirer, and not just a niggardly assessment of the loss to the property owner, would shift incentive structures toward making eminent domain a tactic of last, rather than first, resort.

The answer to the abuse of the eminent domain process is not endless legal inquiries into questions of public benefit, pretextual findings of blight, or other ways to enrich lawyers—the answer is money.

To start with the fundamentals: Of course governments at all levels can be persuaded to abuse their power of eminent domain for the benefit of private interests. Equally of course, private landowners can be persuaded to try to use their holdout powers to extract money from a developer that has already committed significant capital. These are givens.

A couple of real issues are at the heart of the current disastrous state of legal doctrine.

One is philosophical, over whether a city government is allowed to help its large institutions, present or potential, whether these are the New York Times (which also got eminent domain help), the owner of the New Jersey Nets, or Columbia.

Realistically, the answer should be “yes.” The legal confusion over whether the constitutional line can be drawn between publicly owned facilities and facilities that have a public benefit reflects the ambiguity of the world, and is not amenable to definitive resolution. If these institutions already exist, with roots and capital sunk in the city, they are vulnerable to hold-ups and transaction-cost inflation. If a city is trying to help jump-start them, it is competing with other sites that might offer a cleaner deal and needs some mechanism to compensate. In any case, governments, honest as well as corrupt, will find ways to help important institutions, this concern is not illegitimate, and it is better to have the process out in the open rather than channeled through legal fictions such as the level of blight.

The second issue is who should get the increase in value from agglomeration; if parcels A, B, and C are each worth $100,000, but combined they would go for $500,000, who is the rightful owner of that extra $200,000?

The market answer, of course, is the person who identifies the opportunity, packages the landowners with appropriate incentives, and finds the buyer. This is a hard and risky job, which is why entrepreneurs are so rare and valuable. The person who does this job is entitled to whatever chunk of the added value he can get.

The legal confusion over whether the constitutional line can be drawn between publicly owned facilities and facilities that have a public benefit reflects the ambiguity of the world.

But in complex urban areas with many properties it is difficult to pull off such deals, which is why real estate entrepreneurs tend to deal in only a few parcels at a time, or go to the green fields of suburbia. All of this means there are possible gains from large projects that cannot be achieved without invoking the power of eminent domain so that transaction costs are reduced and developers can start down the road confident they will be able to reach the end.

So the answer to the abuse of the eminent domain process is not endless legal inquiries into questions of public benefit, pretextual findings of blight, or other ways to enrich lawyers—the answer is money.

I am fond of citing economist Alfred Kahn’s Civil Aeronautics Board rule that changed the bumping of airline passengers from an administrative procedure into a monetary one.

In the eminent domain context, the problem is that landowners are not being paid enough. The standard of “just compensation” is usually interpreted as the market value of the property as determined by dueling appraisers. This standard can be unfair, as Loyola Law School Professor Gideon Kanner has long argued. It skimps on costs of relocation and upset, and excludes consideration of damage to businesses, which can considerably outweigh the value of the real estate. Tenants, especially businesses, are often seriously short-changed.

Governments and their allies also lowball their offers, counting on the costs of contesting the offer to force a landowner to yield. They play other games—property can be devalued by advance announcements of development plans or by down-zoning or regulatory action that reduces market value before a property gets appraised.

This usual compensation standard also ignores the benefits achieved by the agglomeration of property. Doing so can be defended on the grounds that the existing owners are not performing the entrepreneurial agglomerative function, but neither is the favored institution, which is relying on the power of the state. Assigning this increase in value to the developer, whether private or government-owned, creates big incentives for using eminent domain as opposed to voluntary processes. Think of it as a modern enclosure movement, where the peasants were in theory compensated for the loss of the commons while the enclosers got the benefit of the increase in value.

Governments and their allies also lowball their offers, counting on the costs of contesting the government’s offer to force a landowner to yield.

So the answer to the dilemma is to force the agglomerators to share the gains of the action with existing landowners, which will make the problems more tractable, as landowners perceive that they are better off to accept the situation and developers see that perhaps voluntary action is preferable after all.

One can think of various ways to achieve this. The categories of losses for which compensation is required could be expanded to recognize harm to tenants and to enterprise values. More generous relocation compensation could be imposed. A premium could be attached to the fair market appraisal of the property, perhaps based on an assessment of the overall gains available from the total transaction. Standards of proof could be shifted to favor owners. Legal costs could be granted if an award exceeds the initial offer. Surely, creative greed will come up with other possibilities.

This approach is far from perfect. It does not, for one big thing, directly address the value-destroying deal, in which a government uses its eminent domain power to convert property to lower-value uses as a gift to the politically powerful. The Columbia deal may well be in this category. As Megan McArdle points out, it is certainly value-subtracting in terms of New York City revenues: “We're talking about taking taxpaying private properties and transferring them to a non-profit which will not pay taxes, and will turn a large swathe of Manhattan into a quasi-compound for some of the wealthiest and most privileged people in the city.” Glenn Reynolds is also bitter: “[The property of] West Harlem business owners ... gets taken away to promote the ‘vision’ of what is, in fact, a multibillion-dollar corporation servicing the daughters and sons of the wealthy, the powerful and the connected.”

My heart is with them, but the problem of the nonprofit in contemporary society is a different topic, and the effort to control cronyism of any ilk by hair-splitting eminent domain doctrine is an obvious failure. Focusing on compensation standards is within the competence of courts in a way that psychoanalyzing politically corrupt motives is not, so shifting the incentive structure seems like the best available option.

I agree with most of Kanner’s take on the recent cert denial:

The Justices have been so scalded by the justified public reaction to their wretched handiwork in this field that they have decided to stay out of it. We don’t see much of a chance of correction of this situation in the near future. It seems to us that the justices have concluded that this field of law is a lose-lose situation for them. They lack the five votes that are necessary to articulate any kind of coherent, balanced legal doctrine that litigants and lower courts can reliably use in future cases, so being unable to rectify the mess of their creation, they decided to leave this subject alone because messing with it further, given the court’s composition, can only make things worse.

Except that I am not convinced that there is any possible “coherent, balanced legal doctrine” that would inform us which landowners should be bumped from the flight. So let’s try a different approach.

James V. DeLong is vice president and senior analyst of the Convergence Law Institute and a visiting fellow at the Digital Society.

FURTHER READING: DeLong recently outlined “Protecting Property on the Internet,” discussed protestors in “Tea Time for Vets,” reviewed intellectual property and law in “Googling the Book Settlement,” and noted the Supreme Court’s “Supreme Climate Folly.” Michael Barone explains the importance of property rights to Americans in “Americans Relate to Founders, Not Progressives,” and John Yoo discusses the Justice Department in “Finally, an End to Justice Dept. Investigation.”

Image by Darren Wamboldt/Bergman Group.

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