Eminent Domain

Why do we have it and how has it changed over the years?

What is Eminent Domain?

Eminent Domain is when the government takes ownership (condemns) private property for public use.

Are there any restrictions on the government from using eminent domain?

Yes . . .

According to Article I section 8, #18 of the Constitution

The Government must prove that the condemnation is consistent with the necessary and proper clause.

According to the Takings Clause of the 5th Amendment

The Government must provide just compensation for the property.

Note: Courts usually recognized just compensation as meaning fair market price. The courts will not factor in emotional or sentimental value as part of compensation.

The condemned property must be used for “public use”

Note: In the past, courts have interpreted “public use” as meaning public goods, recently the courts now understand, “public use” as meaning public purpose, thus broader the definition.

Public use interpreted as public goods= Private property to public property

Public use interpreted as public purpose= Private property to public or private property (if serving a public purpose)

Eminent Domain is intended to eliminate the threat of the hold-out problem.

Pareto Improvement-

Change in the allocation of resources that makes at least one person better off without making anybody worse off.

Pareto Efficient (optimal)-

No more improvements can be made without hurting somebody.

Hold Out Problem

Without Eminent Domain (Round 1)

Developer (Government)

Offers Price 1

OwnerAccepts Price 1

Price 1 > Value of land

Value of Land > Price 1

Does not accept Price 1 (Hold out)

Must accept cost and wasted time

No change and no cost

Hold Out Problem

Without Eminent Domain (Round 2)

Developer (Government)

Offers Price 2

OwnerAccepts Price 2

Price 2 > Value of land

Value of Land - Price 2- additional cost(could end up paying more than market price

Does not accept Price 2 (hold out)

Must accept cost and wasted time + additional cost

No change and no cost

If the owner continues to “Hold Out” the developer has 2 options:

Option 1:

Offer a price that far exceeds market price.

This is Pareto inefficient because the owner is better off but the developer is worse off.

Or

Option 2:

Give up on plan the was necessary and proper resulting in the public being. worse off

This is Pareto inefficient because the owner is no worse off but the community is worse off.

The owner is assuming a monopoly over the limited resource of land

Hold Out Problem with multiple Owners (very common and much worse.)

Without Eminent Domain

Developer (Government)

Offers Price 1 to each owner

Owner 3Owner 2Owner 1 Owner 4 Owner 5

Each time an individual owner accepts the developer’s offer the developer becomes more entrenched in the project and therefore becomes increasingly vulnerable to hold outs in future negotiations.

The final owner can hold out and name his price. This Pareto inefficient situation harms the owners, the developer, and the public.

Additionally, if each owner looks forward and reasons backwards the deal will never be complete because every owner will want to be the last owner offered and thus automatically hold out for a better deal.

If each owner continues to “Hold Out” the developer has 2 options:

Option 1:

Offer a price that far exceeds market price.

This is Pareto inefficient because the owner is better off but the developer is worse off.

Or

Option 2:

Give up on plan the was necessary and proper resulting in the public being. worse off

This is Pareto inefficient because the owner is no worse off but the community is worse off.

Now each owner is assuming a monopoly over the limited resource of land

Eminent Domain is intended to serve as a balance between Equity (value) and Efficiency.

Eminent Domain is Pareto Efficient because economically speaking, someone (community) is improving but nobody is worse off.

Negotiations With Eminent Domain

Developer (Government)Offers Price 1 ($300,000)

VD- Value of land to developer (more than $300,000)V0- Value of land to ownerFair market price- $300,000Court Cost - $10,000

Owner accepts

Developer

VD – P1= +

Owner

P1- VO= +

Both have maximized their Utility given the circumstances

Negotiations With Eminent Domain

Developer (Government)Offers Price 1 ($300,000)

VD- Value of land to developer (more than $300,000)V0- Value of land to ownerFair market price- $300,000Court Cost - $10,000

Owner rejects

Developer Files Eminent Domain and the case goes court

Developer counter offers

This will continue until both parties feel that they have the best deal.

Developer

VD – P- court cost

Owner

P1- VO- court cost= +

Eminent Domain puts both the developer and the owner in a Nash Equilibrium where it is in the interest of both parties to settle out of court.

The Developer should look forward and reason backwards,

“If I don’t offer a fair market price and the owner rejects, I will have to go to court, end up paying fair market price and pay additional court cost.”

If the developer has offered fair market price then the Owner should look forward and reason backwards,

“If I reject this offer, I will go to court, only to receive just compensation and still have to court cost.”

Knowing how the other will react it is best for the parties to make and accept fair offers in order to avoid court cost.

The Slippery Slope and Eminent Domain