Document Type



Property Law and Real Estate


The main economic justification for compensating owners for losses from land use restrictions is based on a surprising mistake. Compensation is said to make governments internalize the costs of their actions and therefore enact more efficient regulations. Without compensation, the argument goes, governments operate under a fiscal illusion because, from their perspective, their actions are costless. The problem is that this argument makes no sense as a description of the actual costs to governments. Taxation is the main way governments get revenue, and most taxes depend on the value of property and its permissible uses. If a government restricts land use so as to reduce the value of a parcel or the income produced by it, its residents, or its patrons, tax revenues should go down. If however, the restriction creates benefits, tax revenues should go up. While there are limitations to the accuracy and efficacy of the tax revenue signal, efficient regulations should have a net positive effect on governmental revenues, while inefficient ones should have a net negative effect. Fully compensating owners, in contrast, does not lead the government to accurately internalize societal costs-it rather adds a new and much larger cost. Because this cost usually far exceeds revenue gains, governments may rationally forgo even efficient regulations. Owner compensation, in other words, does not correct fiscal illusion, it creates it. Revealing the illusion of fiscal illusion leaves standing much older arguments that compensation is required as a matter of fairness. But clearing away the main efficiency justification for one-to-one compensation permits clearer-eyed assessment of whether and to what extent fairness may require compensation and reveals that compensation measures in the name of efficiency may, in fact, undermine it.