Eminent Domain and the Free Market

The fallout over Kelo vs. New London has become a topic of conversation throughout many discussion boards, including my350z.com. In the latest tussle, one member asked, Do you think the free market is always the perfect solution? Can you think of any circumstances in which the free market produces unsatisfactory results?, in response to a flurry of attacks on government seizures of property. One particular response (free registration required) is worth noting, from member plezercruz:

The free market always produces the most efficient solution, with some rare exceptions. These exceptions are the standard Coasian transaction costs: search costs, lack of information, spite, etc. Where there is a transaction cost that surpasses the profit gain of a transaction, the most efficient transaction will not happen. If for example, your Saudi landlord won’t sell out of sheer spite, inefficiencies arise. If it is simply too difficult for a buyer to negotiate with all of the owners of a parcel of land, making it too expensive to buy it, inefficiencies arise.

The fact that these ineffiencies occur is the reason why we have governments, and the reason why we have eminent domain. The idea is that by cutting through all the haggling, spite, and sentimental attachments, we can more efficiently produce the results that we want as a society. However, these results are almost always INEFFICIENT because they occur contrary to market forces by government fiat.

The real problem with eminent domain is that it attempts to apply an objective standard to valuation, and value is a subjective determination. We can measure with some accuracy how much land OUGHT to be worth, but we cannot measure how much it is worth to the owner. The solution government has come up with is to outright ignore subjective value, and allow the buyer (government) to determine the fair market price, which (surprise surprise) almost always turns out to be far less than the owner thinks its worth and significantly less than the market would actually bear. I forget the case, but I remember reading in Con Law that government doesn’t even have to pay prevailing market price, it only needs to pay a price high enough that it isn’t completely unreasonable.

Another thing that eminent domain takings overlook is that forced sales necessarily should come at a premium price, not at fair market price. There is a difference between buying land that has come on the market volunatarily and trying to buy land when the owner is not eager to move. The price to buy a parcel of land RIGHT NOW should be significantly higher than fair market price. Eminent domain practice ignores this fact.

All this results in takings which are unjust, unfair, and extremely unpopular. It did not have to be so. If, for example, the Supreme Court had used it’s common sense and realized that taking price should exceed fair market value, then the governments of this country would have to pay a premium to seize land (which is only proper). If that were the case, MOST people would be EAGER to have government take their land. Government would show up and say “We’ll offer you twice what your land is worth” and people would throw parties because the government took their land. That’s the way it ought to be done…if the government “needs” your land badly enough, let THEM pay the premium. You shouldn’t have to be screwed.

I personally hope they take Souter’s home and I hope they give him half what it’s worth. That’s how the rest of us live…why should he be special?

Well said!

10 thoughts on “Eminent Domain and the Free Market”

  1. “Do you think the free market is always the perfect solution?”

    I think it is telling that he frames his question in terms of perfection. Most freemarkerteers (trademark pending) believe that the market usually produces the optimum outcome in any particular situation. Optimum doesn’t mean perfect but rather the best result given the real world tradeoffs. The fact that many people think that ‘perfect” solutions even exist is a big part of the problem.

    I think I have to disagree with the idea that the state should pay a premium for seized lands. Doing so would create its own set of perverse incentives that would drive the politically connected to try to get the state to create justifications for seizing their land at an inflated price. IIRC, such a scandal did occur in the 50’s during the building of California’s highway system.

    I think the optimum system would be to force the state to pay based on the average tax evaluation for the property over the last 5 years or so. This would protect the property owner and give them at least the theoretical ability to raise the valuation on the property.

  2. That would certainly create some interesting dynamics in the post Prop 13 Caliphornia, where tax valuations bear no relation to fair market value, except in the first year.

  3. As a mortgage broker I can certainly attest to the above statement. I would estimate that, on average, the tax assessment of a particular property is generally one-third lower than fair market value. There is much pressure to keep property taxes down (or else a person/business may choose to move to another state) and since the tax is based on land size/square footage, the effect of this pressure is lowered assessments.

    On a different note, my understanding of eminent domain goes something like this: if there is a project (road/military base/school, etc) that would positively affect a particular area, and that affect largely outweighs the interests of the individual, then the land will be seized.

    As mentioned in this post, “fair value” is subjective and should (I think) be handled on a case-by-case basis. This silliness of paying “premium” prices for the property only diverts the cost to us (remember…we pay taxes for this stuff). Wouldn’t a property appraisal do well to determine market value? Fair is fair; no less, no more.

  4. I’m a frequent reader of this blog but, as one not educated in economics, I had to Google the term “Coasian”. In doing so I came across a 1995 artical from the Review Of Austrain Economics at the Mises Institute. It concerns an ongoing property rights discussion between the author, Walter Black, and Harold Demsetz which was precipitated by critique of Harold Coase by Black. It is very long, but relevent to this discussion. It is also in PDF format. Those interested can download it here.

  5. Maurice Cranston wrote

    “The significance of confiscation is not simply that it deprives men of their property, but that it deprives them of their liberty as well. …it must not be forgotten that the right to property is one member of a family of rights, intimately related to the right of freedom; and it is hard to conceive how men can possibly be free if they have no right to possessions, and are wholly dependent for the necessities and comforts of their lives on the grace of some lord or master or communistic government. Property in this sense is inseparable from liberty.

    (What are Human Rights?, Taplinger, NY, 1973, p.50)

  6. if the government “needs” your land badly enough, let THEM pay the premium.

    We have met the THEM and the THEM are us, completely aside from the moral hazard cited by Shannon Love above.

  7. I believe the problem is the way the eminent domain provisions are applied. To me there is a big difference in condeming private property in order to raise more taxes than condemning property to build a highway. Eminent domain condemnations for the public good goes against my beliefs but is more acceptable than enriching a local government. This country was built on the idea that the right to own private property was sacred. It has been defended with blood for over 200 years only to see the right washed away by a court decision. Maybe time to buy another rifle.

  8. The reason for failure in most Third World economies has long been noted to be the lack of firm property and contract rights. In my view, this decision will result in increased uncertainty regarding one’s ownership, and negatively impact transactions as a result.

    If you cannot rely on your property being protected against some city council or zoning board’s idea of superior use for your land, then we have no real right to property at all. If we have no right to property, we have no real rights at all.

    This appears to me justify what had once been prohibited, that government is forbidden to do indirectly what it cannot do directly (i.e. it can’t take your land at gunpoint, nor can it take your land by rezoning it out of existence). Here it confiscates your land merely by discovering a better use for it.

    First the New Deal court dissolution of rights in 1937, now this. What did the socialists need for spies, when the US government is more than happy to legislate constitutional protections away without a fight?

  9. Apropos of the ability of corporations, companies etc. to seize property by means of your ’eminent domain’, how is it that I recall the building of the nearly circular Macy’s in uptown New York about forty years ago. The owners of the site had acquired everything bar one plot, which housed a big old house and a fair-sized garden. This property was owned by an elderly couple who were offered, I believe, over a million dollars (when a million was real money) and their reply was “Don’t want it, don’t need it, wont sell it! Lived here all our lives, and we intend to die right here!” so the store was built with a little piece knocked away from the perfect circle envisaged by the developers becauise that’s the way it was!
    I was in New York on an oil-tanker at the time, and I remember admiring your legal system, which stuck up for the rights of the individual as opposed to the mighty and many! Too bad that the laws are changing so that the little guy gets screwed, and the developers get richer!
    I realise that certain projects need and deserve priority, but there is the thought that ‘one man’s “blight” is another man’s home!

  10. Damn, you guys are fast. I just went through New London today, taking photos of the Kelo and Cristoforo houses, and I see that all the substantive comments I had planned have already been made. I may still post the photos, depending on how they look.

    GUYK gets right to the nub of the issue (again!) with his comment. There is a huge difference between a taking for public use, whether direct (a public park) or indirect (a railroad right of way) and a project made primarily for economic reasons. In this case, the city of New London expects to benefit from higher tax revenues. Pfizer expects to benefit from having hotels, condos, and restaurants next to their research facility. Everyone benefits except the homeowners, who are unlikely to be able to afford water views other than a blow-up kiddy pool.

    Adding to the complication, there is a premium attached to collecting the complete set, like getting Boardwalk and Park Place in Monopoly, or having the cleaners trash the pants, but not the jacket, to one of your suits. All things being equal and without eminent domain, a developer would pay a large premium for the Kelo house to gain title to the entire block.

    So here is my proposed solution (GUYK hints at this): where the property is taken for what is clearly a public use (a right of way, a wharf, a park, a military installation…), the owner should get fair market value plus a premium, say a premium of 25% of market value. If it is taken for any other use, presumably someone else will be making money on the deal. Why should the original owner not make money, too? In the New London case, the property owners should have received a higher premium. Let’s say it’s 200% of market value, as determined by independent assessors (not the tax authorities).

    This eliminates the need to distinguish between “distressed” neighborhoods and others, like the Fort Trumbull area of New London, that are just in the way of a contemplated project. If the Kelo property were truly a run-down wreck (I can testify that it is not), 200% of the value of a run-down wreck, while not a lot of money, would probably suffice and maybe be a relief for the owner; if it were a well-maintained property in an advantageous location (as it appears to be), the owner would receive 200% of a larger number. This would presumably allow Ms. Kelo to buy a similar property in New London or another town on the shore. Please note that tear-downs in Groton Long Point, a couple of miles east, go for maybe $500,000; more if they are as close to the water as the Kelo house.

    Note: the state of Connecticut requires that the property owners receive 110% of the value of their properties in an involuntary taking. In a real estate market like the one we are seeing, that could be either a rounding error or the difference between two weeks in the market. To my mind, it is entirely inadequate.

Comments are closed.