Takings, the exit option and just compensation

This paper started with a discussion of the omission of demoralization costs in traditional economic models of takings. I suggested that this omission in part has to do with the difficulty of incorporating political context in simple models of condemnation. This paper addresses this omission and contributes to the growing literature on the political economy of takings by exploring the effect of the exit option on optimal takings and compensation rules. The introduction of the exit option changes the traditional model of takings in two ways. The first is by making the probability of a taking a function of population. This change allows for an additional strategic dimension to the legislative decision to take. The second is by allowing for state competition in the takings decision. This change allows for the takings decisions of states to be interdependent. An important result of this paper is that the possibilities of exit and state competition significantly alter traditional conclusions of the optimal compensation rule for takings. The model developed in this paper adds an important wrinkle to the seminal model of Blume, Rubinfeld, and Shapiro, which focused singly on the insurance aspect of compensation. Although the exit option provides one way to insure against government confiscation, this paper shows that exit cannot provide full insurance because of the strategic effect that exit has on the legislative decision to take; this is the meaning of Results 1, 4, and 5. However, competition between states in the use of the takings power will limit its exercise as each state internalizes the effects of takings on the size of the population in its jurisdiction; this is the meaning of Result 3. The model in this paper suggests other avenues for future research. For example, the model developed artificially restricted the powers available to state governments. States can finance public projects in many ways other than through eminent domain, such as taxation and purchase. Consideration of the broader question of whether states should take, purchase, or tax to finance a public project when citizens have the exit option requires a richer game theoretic model that allows state legislatures to have a broader range of strategies. The model developed in this paper provides the necessary first step to develop a richer, more complete model of takings, taxation, state competition, and exit.