Victimization, Rent-Seeking and Just Compensation

Victimization, Rent-Seeking and Just CompensationAuthor(s): Dan UsherSource: Public Choice, Vol. 83, No. 1/2 (Apr., 1995), pp. 1-20Published by: SpringerStable URL: http://www.jstor.org/stable/30026939 .

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Public Choice 83: 1-20, 1995. © 1995 Kluwer Academic Publishers. Printed in the Netherlands.

Victimization, rent-seeking and just compensation*

DAN USHER Economics Department, Queen's University, Kingston, Canada K7L 3N6

Accepted 8 March 1993

... though people can adjust satisfactorily to random uncertainty, which can be dealt with through insurance, including self-insurance, they remain on edge when contemplating the possibility of strategically determined losses. For when the bearing of

strategy is evident, one faces the risk of being systematically imposed upon, which seems a risk of a very different order from the risk of occasional, accidental injury. One faces also the rational necessity of devoting a large proportion of his energies and resources to counter-strategy aimed at fending off the risk; where the possibility of loss will be visibly determined by strategy, that possibility cannot be conveniently dismissed from consciousness on the ground that, being uncontrollable, it is not worth thinking about.

Frank Michelman (1967: page 1217)

With some fixed probability, an exogenous event will occur that will make a parcel of land sufficiently valuable for public use so as to trigger a government decision to take the land.

Blume, Rubinfeld and Shapiro (1984: page 72)

Abstract. When should government compensate citizens for harm inflicted by public policy? In practice, all public policy is harmful to somebody, even when it is beneficial to society as a whole. The common view in the legal profession is that a fuzzy but serviceable line can be drawn between "taking" which should be compensated and the proper exercise of the "policy power" where no compensation is warranted. Recently this view has been challenged by some authors who argue that harm to victims of socially-advantageous public policy should never be compensated, and by others who argue that compensation is almost always warranted. The latter would go so far as to proscribe all redistribution of income as a "taking" from the well-to-do. This paper is a defense of the common view against both challenges. The key to the problem is the distinction between unalterable risk and the risk of victimization of citizens by the government, giving rise to rent-

seeking and a general disorganization of society.

* This paper was written while on sabbatical at the economics department of the University of Brit- ish Columbia. I thank the faculty and staff at the economics department for making me welcome.



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1. Introduction

Recent literature on eminent domain has proceeded in two entirely opposite directions. Appealing simultaneously to considerations of efficiency and to the original intent of the American Constitution, Richard Epstein (1985) has argued that the prohibition of taking in the Fifth Amendment - "nor shall private property be taken for public use, without just compensation" - would justify the courts in striking down a vast array of redistributive legislation that has not hitherto been seen as constitutionally restricted. By contrast, Blume, Rubinfeld and Shapiro (1984), Blume and Rubinfeld (1984), Kaplow (1986) and Fishel and Shapiro (1989) have argued that, even in the classic instances of taking where property in land is acquired for public purposes, the appropriate compensation to the former owner of the property is, depending on the circumstances, zero or some fraction of market value. In the name of efficiency, the compensation for taking would be extended to public actions that are not now seen as taking, or would be abolished altogether.'

This paper is primarily about the second of these assertions, but there are implications about the first as well. The paper is a defense of what I believe to be the old-fashioned view that 1) full compensation - neither more or less - is warranted when property is unambiguously taken, as, for instances, when one's house is expropriated because it stands in the path of a new road, and 2) a fuzzy but nonetheless useful line can be drawn between taking where compensation is warranted and the exercise of the "police" power where it is not because, as discussed in Sax (1964) and Michelman (1967), the reasons for compensation do not apply with equal force to all public actions with differential effects upon the incomes of citizens.

This view has been challenged by Blume, Rubinfeld and Shapiro (1984) who argue that compensation generates an externality that would be avoided if compensation were not paid. The crux of the matter is that a landowner who is fully or partially compensated in the event of expropriation takes no account of the impact of the risk of expropriation upon the social return to investment in house-building or other construction. There would be no such impact if, on ex- propriating a plot of land, the government could make full use of the structure on the land as well as the land itself, but, as a rule, this is not so. The typical case is where land is expropriated for a road or a school, and where the structure on the land at the time of expropriation has to be demolished, so that building expenditure by the original owner is wasted. With full compensation, the private return to investment is the return as it would be with no chance of expropriation, for prospect of expropriation is not reflected in the private return to a landowner who would be compensated. By contrast, the social return to investment is the return as it would be with no chance of expropriation, scaled down by the probability of expropriation. The private return must



3

exceed the social return, and the landowner has an incentive to over-invest unless compensation for taking is denied. Consider, for example, a private construction project that yields 9% if the land is not expropriated but conveys no benefit at all if the land is expropriated for some public purpose. Let the market rate of interest be 8% and the risk of expropriation be 2%. From a social point of view or from the point of view of an entrepreneur who bears the full cost of expropriation, the project is unprofitable because the net rate of return is only 7%7o, which is 1%0o less than its alternative cost as measured by the market rate of interest. But the project would be undertaken by an entrepreneur who can expect to be compensated for expropriation.

My objection is to the alleged implications of this argument rather than to the argument itself. I do not deny that compensation for taking may provoke over-investment in housing. Rather I assert that - even at the margin - the social cost of the externality is almost certainly less than the social cost of the rent- seeking and victimization of politically-uninfluential landowners that would occur if compensation were not paid. Under "reasonable" assumptions, the cost of not compensating far exceeds the cost of compensating. Compensation for taking is an aspect of public policy in which the best is the enemy of the good, or, to express the same point in the language of welfare economics, the first best is altogether unattainable and the second best is attained by full compensation. In practice, the externality associated with full compensation should be ignored.

The plan of the paper is to present a simple demonstration of the original argument of Blume, Rubinfeld and Shapiro, to list the principal qualifications that have appeared in the literature together with some qualifications of my own, to explain why, all things considered, full compensation is warranted and, finally, to make a few observations about the distinction between taking and redistribution.

2. The "proof" that full compensation is not warranted

Though the argument in this section is that of Blume, Rubinfeld and Shapiro (1984), the demonstration follows the simpler variant of the argument in Fischel and Shapiro (1989). Imagine a community of people who are risk- neutral and identical in every respect. Each person owns a plot of land on which he builds a house. With building expenditure x and with assurance that one's house would never be expropriated, the value of the completed house - the present value of the services of the house - would be f(x). By assumption, f(0) = 0, f' (x) > 0 and f" (x) < 0, indicating that the value of the additional housing services brought about by an additional dollar of building expenditure is a diminishing function of the amount of building expenditure. In effect, the



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demand curve for building expenditure is downward sloping. However, there is a risk, i, that one's house will be expropriated; think of i as a once-and-for- all risk of expropriation as soon as the house is built or as a compound of future risks throughout the life of the house.2 From time to time, property is required for roads or other public purposes, and housing expenditure on land that is subsequently reassigned to roads is wasted. Were it known in advance that a plot of land would be required for road-building, no house would have been built there; the essence of the problem is that society only finds out which plots of land are needed for roads after the houses have been built. The key assumption here is that, from the point of view of the householder, the expropriation of land is for all practical purposes a random process that nobody can influence and that imposes the same burden, ex ante, on all residents, though, of course, expost, some people's land will be required and other's will not. Think of the roads as public goods from which everybody benefits equally, and suppose that the taking itself is justified in the sense that the benefit of the land in its new public use exceeds by a wide margin the benefit of the house to the original owner.3 To the owner of the house, the risk of expropriation is like the risk of accidental fire, and the analysis to follow of the economics of public compensation is exactly the same.

If there were no risk of expropriation or if expropriation were completely compensated, each person would choose building expenditure x* to maximize the net value of housing services, V*, where

V* = f(x)-x (1)

so that x* would be identified by the condition

f'(x*) = 1 (2)

With a risk of expropriation n and if expropriation were uncompensated, each person would choose building expenditure x** to maximize the expected net value of housing services, V**, where

V** = (1-n)f(x) - x (3)

so that x** would be identified by the condition

(1-n)f'(x**) = 1 (4)

The crux of the matter is that, with a risk of expropriation, x** is socially optimal because the true social value of the house is reduced from f(x) to (1- t)f(x) for any value of x, regardless of whether expropriation is compensated or not.



5

P "price"

of building expenditure

1

,f' (x)

S( 1 -w) f' (x)

deadweight loss

Ax

l~hp

S

building expenditure X** X*

Figure 1. The market for housing.

The circumstances of the typical householder are illustrated with the aid of the demand and supply curves for housing in Figure 1, where building expenditure, x, is shown on the horizontal axis and the "price" of housing is shown on the vertical axis. Units of housing are chosen so that each costs $1. Thus the "supply curve" of housing expenditure becomes a horizontal line one unit above the axis, and a person's "demand curve" for housing is his marginal valuation of building expenditure at all values of x. With no risk of expropriation, the height of the demand curve is f'(x) and the equilibrium is at x*, the crossing of this demand curve with the horizontal supply curve. With an uncompensated risk of expropriation nt, the demand curve shifts to the left, the

height of the new demand curve becomes (1-r)f'(x) and the equilibrium moves to x**, the crossing of the new demand curve with the supply curve. As this new demand curve is a reflection of the true social valuation of housing expenditure, the deadweight loss associated with a policy of compensation for

expropriation may be represented by the shaded area in the figure between the

supply curve and the demand curve over the range from x** to x*. Ignoring the curvature in the demand curve, the deadweight loss becomes 1/2AxAp where Ax and Ap are as indicated on the figure. This is the essence of the argument



6

against compensation for taking in Blume, Rubinfeld and Shapiro (1984). It is correct to the best of my knowledge, just as it would be if the risk were of accidental fire.

There is an important qualification: Full compensation for taking would not lead to excessive building expenditure if each person's compensation were independent of his building expenditure or if each person's tax to finance the entire programme of compensation were dependent upon the amount of building expenditure that he undertakes. Think of householder i as maximizing expected net benefit from housing with due allowance for the risk of expropriation, for compensation in the event of expropriation and for his tax bill to finance his share of the cost of compensation to all householders together. He chooses his building expenditure, xi, to maximize

Vi = (1-t)f(xi)-xi + iCi - Ti (5)

where Ti is his tax bill and Ci is the compensation in the event that his property is expropriated. The deadweight loss arises when, as has been assumed so far,

Ci = f(xi) and Ti = T which is independent of xi, so that V is maximized at x*, as indicated in equation (2), rather than at x** in equation (4) which is socially optimal. But these assumptions about Ci and Ti are not necessarily valid. In fact, the householder's choice of building expenditure would be optimal in accordance with equation (4) if either Ci were independent of xi (as might be the case if compensation were based on the average value of x among all householders) or Ti were dependent on xi (as might be the case if the cost of the programme of compensation were financed by a property tax).3 Full compensation would, in effect, be like a self-financing insurance scheme without moral hazard. Full compensation would do no good in the world of risk neutral people that I have postulated, but it would do no harm either. The deadweight loss would turn out to be illusory and full compensation for taking would be socially optimal.4

As it is my purpose in this paper to defend full compensation despite the deadweight loss, I can afford to ignore the possibility that the deadweight loss is illusory. Thus, I return to the original assumptions that Ti is independent of

xi and that compensation in the event of taking is equal to f(Xi), so that expected compensation is rtf(xi) and xi is excessive. My object is to show that compensation is warranted regardless.

3. Other costs of full compensation and of departures from full compensation

Blume, Rubinfeld and Shapiro have identified one externality associated with full compensation and have shown, correctly in my opinion, that the externali-



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ty would be removed if compensation were denied. However, it is almost an iron law of economics that there is always more than one externality associated with public activity, and that the significance of any one externality depends on the entire mix of externalities at play. Among the relevant externalities are these:

3.1. Settlement cost

It has so far been assumed that the identity and value of the property to be taken are beyond dispute. That is not always so. Public actions may involve the taking of a part of one's property - or some but not all of the strands in the bundle of rights of which property is composed - and the value of the re- mainder may be affected to an uncertain extent. There may be some dispute about the value of a store when the parking lot is taken but the store itself is left in tact. The value of a neighbour's property or business may be decreased or increased in the transaction. Settlement cost is the expenditure of time and money to determine who is harmed by public action, together with the less well- defined loss to society in the failure of the government to assess compensation correctly. Settlement cost shades into rent-seeking cost as discussed below. There may be a case for taking without compensation in transactions between the government and the citizen where the settlement cost is likely to be especially high. This consideration is examined in detail by Michelman (1967).

3.2. Risk

Failure to pay compensation creates a risk among house owners. The risk entails no social cost if house owners are risk neutral. The risk does entail a social cost if house owners are, like most people, risk averse, for risk averse house owners would prefer the sure loss through taxation of if(x) in the event that taking is fully compensated to the probability t of losing the full f(x) in the event that taking is not compensated. As discussed in Blume, Rubinfeld and Shapiro (1984), this consideration, in combination with the excessive expenditure on housing, leads to an optimal compensation rate of s which is greater than zero but still less than one.

3.3. Location of investments

If plots of land in different areas of the city have different probabilities of being required for public purposes, then full compensation for expropriation



8

removes the socially-desirable incentive to build expensive houses on relatively "safe" plots of land. This consideration reinforces the original argument against compensation.

3.4. Social cost of taxation

It is always costly to churn money through the public sector. Compensation must be financed by taxation which entails a deadweight loss of its own that is automatically avoided if compensation is not paid. This consideration also reinforces the original argument against compensation. On marginal deadweight losses in taxation, see Usher (1991).

3.5. Public over-investment

Public officials might misperceive the cost of public projects if the government is not forced by law to pay for what it takes. As discussed in Blume, Rubinfeld and Shapiro, absence of compensation may lead by this route to an over-investment in public projects which is similar in some respects to the over-investment in private housing when total or partial compensation is paid. The optimal rate of compensation becomes a balance between opposing considerations: excessive public expenditure when compensation is not paid, and excessive private expenditure on housing when compensation is paid in full. If these considerations were all that mattered, the appropriate rate of compensation would usual- ly be greater than zero but less than one.

3.6. Majoritarianism

Majority rule voting may generate excessive public expenditure because the majority takes no account of the cost to the minority whose property is to be expropriated. In the long run, each person's expected loss from taking without compensation should be more or less equal to his expected saving in taxation, but everybody loses to some extent from over-investment in the public sector. Fischel and Shapiro (1989) develop a model in which the social cost of public over-investment is balanced against the social cost of private over-investment through the choice of an optimal, constitutionally-determined rate of compensation that is between zero and one.



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3.7. Rent-seeking

I have been reasoning so far as though the taking of one plot of land rather than another is determined by chance. A project presents itself spontaneously from time to time, the specification of the project includes the addresses of the plots of land that the project requires, and the legislature must either accept the project, together with the taking of precisely the land that the project requires, or reject the project altogether. The assumption has been that the legislature may not substitute one plot of land for another. When this assumption does not hold and if compensation for taking is less than complete, there is likely to be a considerable wastage of resources in rent-seeking as each person does what he can to ensure that somebody else's property is taken. Rent-seeking can only be avoided if the designation of the land to be taken is genuinely random or if full compensation is paid so that one does not care too much whether his property is taken or not. See Sterk (1988) and Farber (1992).

3.8. Corruption

If the choice of land to be taken is determined politically rather than at random, the official whose task it is to locate public works may be open to bribery.

3.9. Victimization

The authority to expropriate without compensation would empower the politician in office to victimize citizens, bullying them to contribute to political cam- paigns and to vote appropriately. The threat would be "Vote for me or I will take away your property." Fear would gradually supplant interest as a basis of political activity. A political party that does not serve the public interest, and is unpopular for that reason, could remain in office nonetheless by a credible promise to victimize its opponents. Expropriation without compensation is only one among many means of victimization, but it would be quite effective. Full compensation for taking may be a requirement for the maintenance of democratic government.

Each of these considerations is valid in the sense that models can be developed within which each consideration - alone or in combination with others - is warrant for a rule about compensation for taking. But these considerations are not of equal weight. I shall attempt to show that the political considerations - rent-seeking, corruption and victimization - have by far the greater potential for imposing costs on society, and that they point unambiguously toward full compensation as the superior rule.



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4. The political costs of taking without compensation

At this point in the argument, it is useful to call attention to a critical difference between the assumptions with which Blume, Rubinfeld and Shapiro "prove" that compensation is not warranted and the premises from which many writers in the legal literature have argued that it is. The difference may be seen at a glance in the two quotations at the outset of this paper. Blume, Rubinfeld and Shapiro postulate a world in which i) the rate of compensation is determined, once and for all, in a social contract, ii) the emergence of contemplated public projects and the determination of the plot of land to be expropriated in any given project are entirely random and beyond the influence of the legislature, pressure groups or any human agency, iii) a universally-respected constitution prohibits direct redistribution of income from the minority to the majority and requires that everybody pay the same tax to finance public expenditure. With these assumptions, there is no bargaining, rent-seeking or victimization of unpopular people, and the only externality when expropriation is entirely uncompensated is the overproduction of public goods. On these assumptions, the risk of expropriation is to the householder like the risk of fire. Both risks can be insured privately and free public insurance would induce excessive house building.

Michelman, on the other hand, looks upon the determination of the plot of land to be expropriated as a political rather than a random event, and he sees the basic argument for compensation as originating in precisely that distinction; the appearance of worthwhile public projects may be random but the choice of the plot of land to be expropriated is not. A new school is needed, but that school can be built on land now occupied by your house or by mine. The airport can be located on the east side of town or on the west side of town. That indeterminacy is the source of rent-seeking, corruption and victimization. Michelman could hardly be expected to refer explicitly to rent-seeking because Tullock's classic article appeared at the same time as Michelman's paper, and Krueger's christening of the phenomenon occurred much later, but rent- seeking, as economists now understand the term, is a reasonable designation of the phenomenon to which Michelman refers.

Similarly, Sax (1964:58) argues that the injunction against taking in the Fifth Amendment "was designed to prevent arbitrary government action, rather than to preserve the economic status quo", and that "Scanty though it is, there is at least some basis in the early writers for finding that their real concern was a protection of values only against government conduct which raised the dangers of arbitrary or tyrannical treatment." (57) I do not know enough about the early writers to agree or disagree with Sax about what they actually said, but I agree completely that that is what they ought to have said. With this qualification: that arbitrary treatment is a greater danger to democracy than



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to tyranny. When the despot is arbitrary, he is like a force of nature wreaking havoc randomly but not necessarily risking the destruction of his regime. When a democracy allows itself to be arbitrary, the time and effort of the citizen are diverted from productive activity to the privately profitable but socially- unproductive attempt to direct public favour in his own interest at the expense of his neighbours, the politician in office acquires the means to bully citizens to vote as he wishes and public officials are empowered to sell public decisions for private gain. One should not be too dramatic about these effects. Arbitrary power can never be exorcised altogether, and democracies learn to live with some degree of it. The emergence of extra sources of arbitrary power can nevertheless be costly and dangerous. Justification of compensation for taking based on the political considerations of rent-seeking (3.7.), corruption (3.8.) and victimization (3.9.) flows naturally from the principal justification for private property. The one is a special case of the other. Property must not be taken arbitrarily if property is to be private at all.

These political considerations are quite different from majoritarianism as defined by Fischel and Shapiro. To the assumptions of the Blume, Rubinstein and Shapiro model, as set out above, Fischel and Shapiro add the assumptions that iv) there is a fresh division of citizens into minority and majority for every contemplated project, a minority whose land is to be taken and a majority con- sisting of the rest of the population, and v) the majority chooses whether to undertake the project in the light of its own costs and benefits, regardless of the circumstances or interests of the minority. These considerations can justify a partial compensation for taking to forestall an overproduction of public goods, but the victim of expropriation remains randomly, rather than politically, determined and the principal reason for compensation is still assumed away.

5. The insignificance of the deadweight loss from excess investment in housing by comparison with the cost of rent-seeking

The discriminatory aspect of taking, which plays such a large role in the law- yers' analysis of the phenomenon and which has been explicitly assumed away in the Blume, Rubinfeld and Shapiro paper, can be reintroduced and quanti- fied, albeit imperfectly, as rent-seeking. Specifically, consider a market with these features: 1) Everyone is alike. 2) The benefit of housing for person i is

f(xi) where xi is his housing expenditure and where f(0) = 0, f' > 0 and f" < 0. 3) A fraction T of all houses will be taken for some assumedly worthwhile purpose. 4) There is no compensation for taking. 5) Each person can affect his risk of expropriation by rent-seeking expenditure. Each person's risk of ex-

propriation, ni, is a function of his strategic, or rent-seeking, expenditure, Ei, as compared with E, the average rent-seeking expenditure in the community as a whole.



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A distinction is being drawn between the proportion, n, of properties to be taken for public use and the probability, ni, that the property of person i is to be taken, where ti depends on one's effort or expenditure, Ei, to divert the harm in taking to somebody else. To model this consideration, it is necessary to postulate a connection among ai, Ei, t

and E, where E is defined as average rent-seeking expenditure and where all ti would have to equal r if all Ei were the same, for all rent-seeking expenditures would cancel out in that case. A convenient representation of this relation is

i = (1-ta)t + att(E/Ei)

0< a< 1 (6)

where the parameter a is an indicator of the efficacy of rent-seeking expenditure, and where E is the harmonic mean

(1/E) - (1/n) i=l

(l/Ei) (7)

so that the average of all ti is equal to x. Rent-seeking expenditure is most effective when a = 1 and not effective at all when a= 0. What is being called rent- seeking is the avoidance of a loss rather than the acquisition of a gain, but the essence of the phenomenon is the same. As is typical in rent-seeking models, it is difficult to say a priori how effective rent-seeking expenditure might be in influencing public decision-making. It is difficult to say what values of a are reasonable and realistic. However, it may be helpful to think of a as the elasticity of iti with respect to Ei when each person's rent-seeking expenditure is ini- tially the same. Thus, if a = 1 and starting from a situation where everybody's rent-seeking expenditure is the same, I can reduce the probability that my house will be taken (ni) from, say, one in a hundred (the assumed value of It) to one in a hundred-and-one by increasing my rent-seeking expenditure by one percent.

The householder i chooses xi and Ei to maximize his expected net benefit from housing,

Vi =

(1-ni)f(xi) -

xi-Ei (8)

It follows at once that

(1 - r)f' (x) = 1 (9)

and, with some manipulation," that

E = artf(x) (10)



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where x and E are equilibrium values which have to be the same for everybody because it has been assumed that everybody is the same in his tastes and his circumstances.4 The equilibrium building expenditure is, of course, optimal in this case because there is assumed to be no compensation for taking.

The question now becomes how to compare the magnitude of the rent- seeking cost, E, in the event that compensation is not paid with the magnitude of the deadweight loss, as measured by the area of the shaded triangle in Figure 1, if compensation is paid in full. Ignoring the curvature of the demand curve and employing the standard definition of elasticity, the deadweight loss, D, becomes

D = IAxAp = 1/22xpX(Ap)2/p (11)

where exp is the absolute value of the elasticity of demand at x**, and where Ax and Ap are as indicated on Figure 1. The term p in equation (11) can be dropped because it is the height of the demand curve at x**, which turns out to equal 1. The value of Ap is the difference between the heights of the two demand curves at x*. Specifically,

Ap = f'(x*) - f'(x*)(1-nt) = t (12)

because, as indicated in equation (2) above, f'(x*) = 1. The deadweight loss becomes

D = 1/2expX7L2 (13)

which may now be compared with E. The essence of the rent-seeking argument for full compensation is that, with

almost any reasonable choice of parameters, the cost of rent-seeking if compensation is not paid is very much greater than the cost of the deadweight loss if compensation is paid. Consider an example. Suppose a = 1/2, Exp

= 1, X* = $200,000, f(x**) = $300,000 and n = 1/1000. With these parameters, the deadweight loss when compensation is paid becomes

D = 1/2 x 1 x $200,000 x [1/1000]2 = 10 cents

on a house worth $300,000, while the rent-seeking expenditure when compensation is not paid becomes

E = 1/2 x [1/1000] x $300,000 = $150.

Obviously, the values of D and E depend on the choice of parameters, but it



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is hard to find reasonable parameters for which E is not substantially greater than D. For instance, if t increases a hundred fold to 1/10, the value of D increases to $1000 and the value of E increases to $15,000.

There remains the possibility that since the deadweight loss vanishes when there is no compensation for taking, while the rent-seeking cost vanishes when there is full compensation, there may be some partial compensation for which the sum of the two costs is minimized. To consider this possibility, let s be the portion of the loss that is compensated, where 0_ s s 1 by definition, where s = 0 when there is no compensation and where s = 1 when there is full compensation. It now becomes necessary to construct measures of deadweight loss and rent-seeking cost, D(s) and E(s), for all possible values of s. The expression for E(s) is easy. Since householders are risk neutral, they must be indifferent between a risk n when a fraction s of the loss is compensated and an uncompensated risk of (1-s)n. Thus, the expression for E(s) is derived by replacing t by (1-s)n in equation (10)

E(s) = (1-s)anf(x) (14)

Necessarily, the expression for E(s) in equation (14) reduces to the expression for E in equation (10) when s = 0, and E(s) vanishes when s = 1; E(0)= E and E(1)= 0.

The expression for D(s) is a bit more complicated. The height of the private demand curve for building expenditure, which would be f'(x) as shown in Figure 1 when taking is fully compensated, becomes (1-n(1-s))f'(x), where

n(1-s) is the uncompensated equivalent of a risk n with compensation s. Thus Ap in the analogue to equation (12) above becomes

Ap = f'(x*)[1-n(1-s)] - f'(x*)[1-n] = f' (x*)[1-n(1-s)] - f' (x*)[1-n(1-s)] { (1-n)/[1-n(1-s)] } = us/[1-n(1-s)] (15)

because f'(x)[1-t(1-s)] = 1 at x= x*. The expression for D in equation (11) remains valid except that the value of Ap, which had been determined in accordance with equation (12), must now be determined in accordance with equation (15). For any given s, the deadweight loss becomes

D(s) = 1/2V22S2x*cxp/[1-n(1-s)] (16)

Necessarily, the expression for D(s) in equation (16) is the same as the expression for D in equation (13) when s= 1, and D(s) vanishes when s = 0; D(0)= 0 and D(1)= D.

The total cost, T(s), of rent-seeking and deadweight loss together is



15

T(s) = E(s) + D(s) (17)

By definition, the optimal rate of compensation is that for which T(s) is minimal. Thus, the optimal s can never be less than 1 unless 6T/6s = 0 for some value of s between 0 and 1, or 6T/As > 0 for all feasible values of s. In other words, the optimal s has to be 1 if 6T/8s is negative for all admissible values of s. Since rent-seeking cost decreases in proportion to s while deadweight loss increases in proportion to s2, it follows that 8T/6s would be non-negative in the vicinity of 1 if it is non-negative anywhere at all. But, as s approaches 1, equation (17) reduces to

T(s) = (1-s)E + s2D (18)

where D [equal to D(1)] and E [equal to E(0)] are as indicated in equations (13) and (10) and are both independent of s. Consequently, in that region,

6T/6s = -E + 2sD (19)

which has to be negative as long as E > 2D, as was the case in both of the exam- ples presented above.6 Thus there is a reasonable presumption, though no absolute proof, that 6T/8s < 0 for all values of s, so that the optimal s is equal to 1 and full compensation for taking is warranted.

6. Rent-seeking and victimization

The term "rent-seeking" is typically applied to competition among citizens for a prize in the gift of the government in circumstances where the competition itself is of no social value. In Krueger's (1974) classic example, the government establishes a quota on imports, and would-be importers scramble expensively for shares. There is no formal analysis of what might be called a higher level of rent-seeking in which rent-seekers devote resources to persuading the government to enlarge the prize; the prize is what it is and the rent-seekers react to it. The distinction between reacting to a given prize and seeking to influence the rules of the rent-seeking contest may be important for the assessment of compensation for taking. If taking were uncompensated, much of the rent- seeking activity of potential victims of taking would be directed to the election and appointment of sympathetic officials, and not just to the task of influencing the officials who happen to be in place.

Compensation for taking is society's defenses against the thin edge of a very nasty wedge. Abolish compensation, and citizens compete to shift the burden of public expenditure. Such competition includes the effort to appoint or elect public officials who know how to reciprocate favours. Public officials would



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be chosen more for their allocative proclivities than for their skill in conducting the nation's business. The social cost of uncompensated taking includes a ten- dency toward corruption of the democratic process, a general inefficiency in government and the victimization of those who are less adept at the political game or who constitute a natural minority through some visible, geographic or occupational trait.7

The abolition of compensation for taking would be similar in kind, though by no means as extreme a step, to the replacement of our rule-based tax system with ad hominem taxation, where each person's tax is determined individually by a vote in the legislature.8 Compensation for taking plays a role on the expenditure side of the public accounts analogous to the role of horizontal equity on the tax side. Both principles are a bit fuzzy at the edges, both help to defend the citizen from predatory government and both are derivative of the more general principle that the protection of property rights is an essential task of government in a free and prosperous society.

7. Taking, the police power and the redistribution of income

The development of a case for full compensation in the classic, unambiguous instances of taking may cast some light on the question of why compensation is commonly believed to be unwarranted when ordinary legislation or regula- tion by the government harms some citizens for the benefit of others. Pure redistribution of income, as exemplified by the graduated income tax or the negative income tax, is taking in the sense that some people are made better off and others are made worse off, but pure redistribution is not treated as unconstitutional in the United States or Canada. It has been argued that redistributive legislation should be unconstitutional because, by the very definition of redistribution, no compensation to the losers can ever be paid. Epstein (1985) seems to hold that view, almost as though there is a God-given standard of efficiency that is enshrined in the U.S. Constitution and that the courts can and must enforce.

As a first step in evaluating this assertion, I would be inclined to ask why a legislature which can, one way or another, prevail over the courts if really determined to do so, does defer voluntarily on certain matters, and whether such deference would be still extended if the courts were to banish redistribution altogether. My tentative answer to these questions is that the legislature defers to the courts when the alternative to deference is seen as chaos and when the courts are not seen as blocking the will of the people on a matter of considerable significance. In particular, I suspect that the legislature defers to the courts over compensation for taking because of the rent-seeking, victimization



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and corruption that uncompensated taking would entail. I also suspect that the legislature would not respect a ban on the redistribution of income because a majority of the people demands redistribution and because redistribution is

very much less susceptible to these vices. Redistribution differs fundamentally from taking in that redistribution is

almost a single peaked issue, while taking, as commonly understood, is not. In so far as one can quantify redistribution as more or less, and in so far as redistribution creates disincentives which cause the national income to be lower than it might otherwise be, each voter can compare his direct benefits or costs from redistribution with his share of the cost to society as a whole from the general lowering of the national income. By means of that comparison, he can determine his preferred degree of redistribution, such that he would be worse off with either more redistribution or less. It is characteristic of such a comparison that, the poorer you are, the more redistribution you want. On these conditions, the public choice of the degree of redistribution becomes a single-peaked issue for which there is a median voter whose preferred degree of redistribution is supported by a majority in the legislature against any alternative (Atkinson, 1973 and Usher, 1980). Thus, ideally, there is no room in the determination of the degree of redistribution for rent-seeking, lobbying or political manipulation. The degree of redistribution is uniquely determined by the constellation of preferences in the electorate and the legislature. That is not true of ordinary taking without compensation which is the very antithesis of a single-peaked issue. It is as though, referring to equation (6), the a for the taking of property without compensation were substantial, while the a for a pure redistribution were very close to zero. To be sure, this distinction is somewhat overdrawn and open to a number of qualifications, but there is enough in it to undermine the proposition that redistribution and taking without compensation are essential- ly the same.

There is another important consideration. Regardless of the inclinations of the legislature and the courts, the legislature cannot defer to the courts over a wide range of legislation because the issues to be resolved would return to the legislature indirectly through the appointment of judges. In this imperfect world, judges are not legal automata, but people with interests and prejudices of their own. Thus, in appointing judges, the legislature can if it wishes prede- termine what the courts' decisions will be. The higher the stakes, the more like-

ly are prospective judges to be chosen for their political views and their willing- ness to commit themselves on a variety of issues. Learning may suffice when the courts are limited to the interpretation of the law and to the preservation of basic civil rights, including the right not to have one's property expropriated, that almost all voters and legislators wish passionately to see preserved. It is another matter when judges are expected to oppose a permanent interest



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of a majority of the voters. The unfortunate prominence of the judges' views on abortion in appointments to the U.S. Supreme Court is a foretaste of what might happen if judges could block legislation involving a large uncompensated redistribution of income. The waste of effort in lobbying, rent-seeking and political manipulation might turn out to be greater when the courts are pre- pared to thwart the will of the majority by decreeing redistributional legislation to be unconstitutional than when the legislature has undisputed authority in that realm. It is especially to be feared that rent-seeking and corruption would be redirected from the legislature to the courts, and that the role of the courts as the defenders of basic freedoms would be undermined.

I do not mean to deny that some laws and many regulations have effects that are similar to taking without compensation and that it is often difficult in practice for the courts to determine whether compensation is warranted. I have nothing useful to add to the legal literature on the subject, except perhaps to emphasize that the presence of hard cases on the margin need not interfere with the clear and simple cases at the extremes: on the one side, unambiguous expropriation of property for which compensation is warranted, and, on the other, changes in laws for which it is not.

Finally, there is in Canada and many other countries a curious discrepancy in the practice of politics between taking and giving. A government may not take away one's house, but it may give somebody a house at public expense, or provide a firm with an investment subsidy, or forgive tax for a variety of questionable reasons, or provide money quite arbitrarily to a lower level of government. Nor is it thought appropriate to pay negative compensation (that is, to impose special taxes) when public actions increase the value of a person's property. Perhaps there is implicit judgment that the social cost having a few large losers and many small gainers, as in taking without compensation, is less than the social cost of having a few large gainers and many small losers who are each taxed a little to cover the cost of public largess. That may be so when giving is a rare event. The greater the prevalence of giving, the more like taking does giving become and the more susceptible does giving become to the social costs in wastage of resources and disorganization of society that are to some extent escaped when taking without compensation is unconstitutional.

Notes

1. For a collection of views about the rationale for and limits to taking, see Mercuro (1992). 2. When the annual value of the services of a house is g(x), the rate of interest is r, the rate of

depreciation is d and there is no risk of expropriation, the present value of the house is g(x)/(r + d). When, instead, there is an annual risk of expropriation of cp, the present value is reduced to g(x)/(r + d + p). Since the present value of the services of the house is f(x), the value



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of it may be defined implicitly by setting f(x) = g(x)/(r + d) and (1-it)f(x) = g(x)/(r + d + (p). Thus, 7t = p/(r + d + cp). With a rate of interest of 5%, a rate of depreciation of 4% and an annual risk of expropriation of 1%, the value of xt becomes 1/10.

3. Ulen (1992) has proposed a "dual-constraint" rule on taking. On his view, taking should be

fully compensated, but disallowed altogether unless the Courts are convinced that the taking is for a public good of greater value to the community as a whole than the taken property is to its owner. Without commenting on the merit of the proposal, I am assuming throughout this paper that Ulen's qualification is, in fact, met.

4. Setting compensation in accordance with what the householder should spend rather than on what he actually does spend is in the spirit of a suggestion by Rose-Ackerman (1989) that liabil- ity for accidents be assessed with reference to the cost of precautions as they should have been rather than as they actually were. There is some question about what municipalities actually do; see Munch (1976). Is the owner of an expropriated house compensated for the irremovable gold faucets, or is he compensated for no more than the cost of normal and reasonable building expenditures? If municipalities compensate in accordance with appropriate rather than actual building expenditure, then there is no externality associated with full compensation for taking.

5. From the first order condition when Vi is maximized with respect to E, it follows that

f(xi)6iri/8Ei = -1 where the derivative 6xi/SEi can be determined from equations (6) and (7). From the definition of E in equation (7), it follows that 6 E/8Ei = (l/n)(E/Ei)2, and from the definition of ni in equation (6), it follows that

Sni/6Ei = act[Ei(6 E/6Ei)- E]/(Ei)2

Pulling all this together, we see that

-l/f(xi) = at[Ei(l/n)(E/Ei)2- E]/(Ei)2

which reduces to

E = aitf(x)(n-l)/n in equilibrium where everybody's behaviour and everybody's risk must be the same. The term (n-l)/n is ignored in equation (14) in the text on the assumption that the population is large.

6. The complete expression for ST/Ss is

-aitf(x) + t2SXxp,/[l-(Il-s)] - 1/2V23S2XExp/[1-(1-S)]2

which is equal to

-E + 2sD/[1-t(l-s)] - s2tD/[1-t(l-s)]2

and is less than -E + 2D for all feasible values of s. 7. Note however that compensation may introduce rent-seeking cost of its own. Michelman's set-

tlement cost may be interpreted as rent-seeking cost when the value of property, f(x), cannot be accurately observed by the government and when resources are devoted to persuading the

government that a large compensation is warranted. This consideration probability accounts for a reluctance on the part of the courts to award compensation for taking when the loss is ill-defined, and it may explain the attractiveness of "physical invasion" as the test of whether taking is compensatable.

8. Ad hominem taxation is the antithesis of what Henry Simons (1938) advocated in this classic study of equity in taxation.



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References

Atkinson, A.B. (1973). How progressive should the income tax be? In E. Phelps (Ed.), Economic justice. Harmondsworth: Penguin Books.

Blume, L. and Rubinfeld, D.I. (1984). Compensation for takings: An economic analysis. Califor- nia Law Review 72: 569-624.

Blume, L., Rubinfeld, D.L. and Shapiro, P. (1984). The taking of land: When should compensation be paid? Quarterly Journal of Economics 99: 71-92.

Epstein, R.A. (1985). Takings: Private property and the power of eminent domain. Cambridge, Mass.: Harvard University Press.

Farber, D. (1992). Economic analysis and just compensation. International Review of Law and Economics 12: 125-138.

Fischel, W.A. and Shapiro, P. (1989). A constitutional choice model of compensation for takings. International Review of Law and Economics 9: 115-128.

Kaplow, L. (1986). An economic analysis of legal transactions. Harvard Law Review 99: 509-617. Krueger, A.O. (1974). The political economy of the rent-seeking society. American Economic

Review 64: 291-303.

Mercuro, N. (Ed.) (1992). Taking property and just compensation. Boston: Kluwer Academic Publishers.

Michelman, F.I. (1967). Property, utility and fairness: Comments on the ethical foundations of

"just compensation" law. Harvard Law Review 80: 1165-1258. Munch, P. (1976). An economic analysis of eminent domain. Journal of Political Economy 84:

473-497.

Rose-Ackerman, S. (1989). Dikes, dams and vicious hogs: Entitlement and efficiency in tort law. Journal of Legal Studies 18: 25-50.

Sax, J.L. (1964). Takings and the police power. The Yale Law Journal 75: 36-76. Simons, H.C. (1938). Personal income taxation. Chicago: University of Chicago Press. Sterk, S.E. (1988). Nollan, Henry George, and exactions. Columbia Law Review 88: 1731-1751. Tullock, G. (1980). Efficient rent-seeking. In Buchanan, J.M., Tollison, R. and Tullock, G.

(Eds.). Towards a theory of the rent-seeking society. College Station, Texas: Texas A&M University Press.

Ulen, T.S. (1992). The public use of private property: A dual-constraint theory of efficient government takings. In N. Mercuro (Ed.), Taking property and just compensation. Boston: Kluwer Academic Publishers.

Usher, D. (1980). The economic prerequisite to democracy. Oxford, Basil Blackwell. Usher, D. (1991). The hidden cost of public expenditure. In R. Bird (Ed.), More taxing than taxes?

San Francisco: ICS Press.



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Victimization, Rent-Seeking and Just Compensation

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