Economic Analysis of Taking Rules: The Bilateral Investment Case

Our analysis focuses on a situation where a landowner and the government invest prior to the government's taking decision. When the government suffers from budgetary fiscal illusion, optimal compensation equals the hypothetical value of the landowner's property had she invested efficiently. In contrast, under a government that maximizes social welfare, this regime may fail to induce the first best. This insight stands in contrast to the literature, e.g., Miceli (1991), where this regime has been shown to induce the socially optimal solution.