HANS-BERND SCHÄFER, RAM SINGH
Abstract: In this paper, we model and examine the effects of two salient features of eminent-domain law and its use. First, the compensation is less than full. Second, the government is not a perfect agent of society. Once these features are taken into account, several claims in the existing literature do not hold. Our results question the fiscal illusion theory. We show that full compensation ensures efficiency neither of the takings nor of the investment decisions. Moreover, departure from efficiency can get worse with the tightening of budget constraints. However, undercompensation, combined with the provision of restitution, delivers a better outcome in terms of investment choices by the owners and the taking decisions and choice of projects by the government. Furthermore, we show that fixed-compensation schemes generally are not efficient even if the government is benevolent, but undercompensation can still deliver an outcome more efficient than full compensation.