Economic Value or Fair Market Value: What Form of Takings Compensation Is Efficient?

The scholarly literature on takings compensation emphasizes incentives for condemnors and condemnees. The widely accepted prediction that full compensation leads to overinvestment by condemnees, however, is not based on the correct understanding of the takings law in the United States. Condemnors are often assumed to be social wealth maximizers or to suffer from fiscal illusion, both theories lacking empirical support. In addition, costs and accuracy of assessing property value for takings compensation purposes are important, yet have never been systematically analyzed. I argue that owners will generally invest efficiently if either economic value or fair market value (assessed under current U.S. law) is adopted as the takings compensation standard. Government officials seek to maximize their own political interests, not their agency's or society's interests, when making decisions on condemnations. If only condemnors’ and condemnees’ incentives are considered, economic value compensation is the most efficient; fair market value compensation will be suboptimal. After taking into account assessment costs and assessment accuracy, I further argue that fair market value plus a schedule of proportional bonuses should be given to homeowners. Nonresidential property owners, because their economic value approximates fair market value, are entitled only to fair market value compensation without bonuses.