Compact of Free Association: Palau's Use of and Accountability	 
for U.S. Assistance and Prospects for Economic Self-Sufficiency  
(10-JUN-08, GAO-08-732).					 
                                                                 
The Compact of Free Association between the Republic of Palau and
the United States entered into force on October 1, 1994, with the
U.S. interest of promoting Palau's self-sufficiency and economic 
advancement. The compact and its related subsidiary agreements	 
provide for a 15-year term of economic assistance. In fiscal year
2009, the two governments must review the terms of the compact	 
and related agreements and agree on any modifications. The	 
Department of the Interior (DOI) has primary responsibility for  
oversight of Palau's use of compact funds. GAO was requested to  
report on (1) the provision of compact and other U.S. assistance 
to Palau in fiscal years 1995-2009; (2) Palau's and U.S.	 
agencies' efforts to provide accountability over Palau's use of  
federal funds in 1995-2006; and (3) Palau's prospects for	 
achieving economic self-sufficiency. GAO reviewed Palau's compact
annual reports, financial statements and internal control reports
for fiscal years 1995-2006, as well as other compact-related	 
documentation. GAO interviewed officials from the U.S. and Palau 
governments and conducted fieldwork in Palau.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-08-732 					        
    ACCNO:   A82311						        
  TITLE:     Compact of Free Association: Palau's Use of and	      
Accountability for U.S. Assistance and Prospects for Economic	 
Self-Sufficiency						 
     DATE:   06/10/2008 
  SUBJECT:   Accountability					 
	     Cost analysis					 
	     Economic analysis					 
	     Economic development				 
	     Economically depressed areas			 
	     Federal aid programs				 
	     Federal aid to foreign countries			 
	     Financial disclosure				 
	     Financial management				 
	     Financial statement audits 			 
	     Fiscal policies					 
	     Foreign aid programs				 
	     Foreign economic assistance			 
	     Foreign financial assistance			 
	     Foreign governments				 
	     Foreign policies					 
	     Funds management					 
	     Internal controls					 
	     International agreements				 
	     International economic relations			 
	     International relations				 
	     Private sector					 
	     Reporting requirements				 
	     Trust funds					 
	     Cost estimates					 
	     Compact of Free Association			 
	     Palau						 

******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO Product.                                                 **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
******************************************************************
GAO-08-732

This is the accessible text file for GAO report number GAO-08-732 
entitled 'Compact Of Free Association: Palau's Use of and 
Accountability for U.S. Assistance and Prospects for Economic Self-
Sufficiency' which was released on June 10, 2008.

This text file was formatted by the U.S. Government Accountability 
Office (GAO) to be accessible to users with visual impairments, as part 
of a longer term project to improve GAO products' accessibility. Every 
attempt has been made to maintain the structural and data integrity of 
the original printed product. Accessibility features, such as text 
descriptions of tables, consecutively numbered footnotes placed at the 
end of the file, and the text of agency comment letters, are provided 
but may not exactly duplicate the presentation or format of the printed 
version. The portable document format (PDF) file is an exact electronic 
replica of the printed version. We welcome your feedback. Please E-mail 
your comments regarding the contents or accessibility features of this 
document to [email protected].

This is a work of the U.S. government and is not subject to copyright 
protection in the United States. It may be reproduced and distributed 
in its entirety without further permission from GAO. Because this work 
may contain copyrighted images or other material, permission from the 
copyright holder may be necessary if you wish to reproduce this 
material separately.

Report to Congressional Committees:

United States Government Accountability Office: 
GAO:

June 2008:

Compact Of Free Association:

Palau's Use of and Accountability for U.S. Assistance and Prospects for 
Economic Self-Sufficiency:

GAO-08-732: 

GAO Highlights:

Highlights of GAO-08-732, a report to congressional committees. 

Why GAO Did This Study:

The Compact of Free Association between the Republic of Palau and the 
United States entered into force on October 1, 1994, with the U.S. 
interest of promoting Palauï¿½s self-sufficiency and economic 
advancement. The compact and its related subsidiary agreements provide 
for a 15-year term of economic assistance. In fiscal year 2009, the two 
governments must review the terms of the compact and related agreements 
and agree on any modifications. The Department of the Interior (DOI) 
has primary responsibility for oversight of Palauï¿½s use of compact 
funds. GAO was requested to report on (1) the provision of compact and 
other U.S. assistance to Palau in fiscal years 1995-2009; (2) Palauï¿½s 
and U.S. agenciesï¿½ efforts to provide accountability over Palauï¿½s use 
of federal funds in 1995-2006; and (3) Palauï¿½s prospects for achieving 
economic self-sufficiency. GAO reviewed Palauï¿½s compact annual reports, 
financial statements and internal control reports for fiscal years 1995-
2006, as well as other compact-related documentation. GAO interviewed 
officials from the U.S. and Palau governments and conducted fieldwork 
in Palau. 

What GAO Found:

For fiscal years 1995-2009, U.S. aid to Palau is expected to exceed 
$852 million. Compact direct assistance will account for 48 percent of 
U.S. assistance; this assistance provides general budgetary support for 
Palauï¿½s government operations, including initial investment in a trust 
fund intended to provide annual distributions of $5 million in 1999-
2009 and $15 million in 2010-2044. Compact federal services such as 
postal, aviation, and weather services will account for about 3 percent 
of assistance, and construction of a road, finished in 2007, will 
account for 17 percent of assistance. Palauï¿½s receipt of federal 
programs, providing services such as education grants and community 
health care, will account for approximately 31 percent of assistance.

Single audit reports for fiscal years 1995-2006 show that Palau has 
made progress in its financial accountability through improvements in 
the timeliness and reliability of its financial statements. However, 
the reports show that Palau has persistent internal control weaknesses 
over financial reporting and over compliance with laws and regulations 
governing federal grants. According to Palau officials, inadequate 
capacity in financial accounting resources and expertise limits Palauï¿½s 
ability to address these weaknesses in a timely way. These weaknesses 
put at risk Palauï¿½s ability to sustain its progress in financial 
accountability and to operate a major federal program according to 
applicable requirements. Palau met most compact and subsidiary 
agreement accountability requirements. However, although DOI used 
single audit reports and Palauï¿½s compact annual reports to monitor 
Palauï¿½s use of compact funds, DOIï¿½s oversight was lacking in some 
matters.

Palauï¿½s prospects for economic self-sufficiency depend on four key 
factors: 

* Levels of continued U.S. assistance. Given the $10 million scheduled 
increase in Palauï¿½s annual trust fund withdrawals in fiscal year 2010, 
the expiration of $13.3 million in compact direct assistance will 
likely reduce Palauï¿½s national government revenues by less than 4 
percent. However, future levels of discretionary federal 
programsï¿½estimated at $11.9 million in 2009ï¿½could have a more 
significant fiscal impact. Also, unless compact federal services are 
extended, Palau will lose services funded by U.S. agencies estimated to 
cost almost $1.6 million in 2009. 

* Availability and value of trust fund distributions. Palauï¿½s trust 
fund can distribute $15 million per year for 35 years if it earns a 
compounded annual return of at least 8.1 percent, a rate lower than the 
average earned thus far. However, market volatility could lead to the 
trust fundï¿½s depletion after 2016. Moreover, inflation will cause the 
distributions to lose value over time. 

* Fiscal reform. To reduce its reliance on trust fund financing, Palau 
will require fiscal reforms to increase revenues and decrease 
expenditures. 

* Private sector growth. Palau will need to improve its business 
environment by addressing problems with its foreign investment climate; 
financial system; and land, labor, and commercial policies that 
currently discourage private sector growth.

What GAO Recommends:

GAO recommends that the Secretary of the Interior direct the Office of 
Insular Affairs to formally consult with the government of Palau 
regarding Palauï¿½s financial management challenges and assist Palau in 
building financial management capacity. DOI and Palau agreed with GAOï¿½s 
recommendations. 

To view the full product, including the scope and methodology, click on 
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-732]. For more 
information, contact David Gootnick at (202) 512-3149 or 
[email protected]. 

[End of section] 

Contents:

Letter:

Results in Brief:

Background:

U.S. Assistance to Palau in 1995-2009 Is Projected at More Than $852 
Million:

Palau Made Progress in Accountability but Has Limited Capacity to 
Address Internal Control Weaknesses; Interior's Oversight Has Been 
Limited:

Palau's Prospects for Economic Self-Sufficiency Depend on Multiple 
Factors:

Conclusions:

Recommendation for Executive Action:

Agency Comments and Our Evaluation:

Appendix I: Objectives, Scope, and Methodology:

Appendix II: Relevancy of Amendments Made to FSM and RMI Compacts for 
Palau Compact Review:

Appendix III: Economic Information for Palau:

Appendix IV: Technical Notes on the Trust Fund Simulation Model:

Appendix V: Compact Road:

Appendix VI: Selected Federal Programs:

Appendix VII: Compact Assistance Provided by the Department of the 
Interior:

Appendix VIII: Comments from the Department of Interior:

Appendix IX: Comments from the Republic of Palau:

Appendix X: GAO Contact and Staff Acknowledgments:

Tables:

Table 1: Key Provisions of the Palau Compact of Free Association and 
Related Subsidiary Agreements:

Table 2: Compact Direct Assistance Provisions and Amounts, 1995-2009:

Table 3: Compact Federal Services, 1995-2009:

Table 4: Single Audit Act Report Submissions, 1995-2006:

Table 5: Financial Statement Audit Opinions for Palau, 1995-2006:

Table 6: Palau's National Government Finances, 2000-2006:

Table 7: Economic and Fiscal Data for the Three Compact Countries:

Table 8: Nominal Returns Distribution Based on Historical Data, 1970- 
2007:

Table 9: Cross-Correlation and Serial Correlation of Historical Annual 
Returns:

Table 10: Annual Compounded Returns and Standard Deviations for Large 
Company and Small Company Stocks and for U.S. Treasury Bills (in 
percentage), 1970-2007:

Table 11: Trial Values of the Palau Trust Fund Balance, 2025-2044:

Table 12: Historical Rates of Return of a Portfolio Based on the Palau 
Trust Fund Asset Allocation (in percentage):

Table 13: Discretionary Federal Program Funds Expended in Palau 2006:

Table 14: Compact Assistance Provided by the Department of the 
Interior, Estimated Payments, 1995-2009:

Figures:

Figure 1: Location and Map of Palau:

Figure 2: Palau National Government Expenditures and Revenues:

Figure 3: U.S. Assistance to Palau 1995 - 2009 (projected):

Figure 4: Top Five U.S. Agencies' Expenditures in Palau, 1995 - 2006:

Figure 5: Palau National Government's Potential Revenues in 2009:

Figure 6: Palau's Trust Fund Account Balance with Three Rates of Return:

Figure 7: Probability That Palau Trust Fund Will Be Depleted Given 
Market Volatility, 2010-2044:

Figure 8: Compact Road at Beginning and End of Construction:

Figure 9: Map of Palau Roads and States:

Figure 10: Compact Road Construction Terrain and Cut Slope Failure:

Figure 11: Compact Road Project Timeline:

Figure 12: Grass-Cutting Crews and Damaged Guardrail:

Abbreviations:

ADB: Asian Development Bank:

CAT: Civic Action Team:

DOD: Department of Defense:

DOT: Department of Transportation:

Education: Department of Education:

FAA: Federal Aviation Administration:

FAC: Federal Audit Clearinghouse:

FASEG: Freely Associated States Education Grant:

FSM: Federated States of Micronesia:

GDP: gross domestic product:

HHS: Department of Health and Human Services:

IMF: International Monetary Fund:

Interior: Department of the Interior:

OIA: Office of Insular Affairs:

OIG: Office of the Inspector General:

OMB: Office of Management and Budget:

PNCC: Palau National Communications Corporation:

NWS: National Weather Service:

RMI: Republic of the Marshall Islands:

SEPPIE: Special Education Program for Pacific Island Entities:

State: Department of State:

USACE: U.S. Army Corps of Engineers:

USDA: Department of Agriculture:

USPS: U.S. Postal Service: 

[End of section] 

United States Government Accountability Office:
Washington, DC 20548:

June 10, 2008:

The Honorable Jeff Bingaman: 
Chairman: 
The Honorable Pete V. Domenici: 
Ranking Member: 
Committee on Energy and Natural Resources: 
United States Senate:

The Honorable Donna M. Christensen: 
Chairwoman: 
The Honorable Luis G. Fortuï¿½o: 
Ranking Member: 
Subcommittee on Insular Affairs: 
Committee on Natural Resources: 
House of Representatives:

The Compact of Free Association between the Republic of Palau and the 
United States entered into force on October 1, 1994, with the U.S. 
interest of promoting Palau's self-sufficiency and economic 
advancement. The compact and its related subsidiary agreements 
established a 15-year term of economic assistance and specified 
security and defense relations between Palau and the United States. 
Since 1995,[Footnote 1] U.S. aid to Palau has included assistance 
provided for in the compact--direct assistance from 1995 through 2009, 
including investment in a trust fund intended to produce an annual 
distribution of $15 million from 2010 through 2044; federal services; 
and construction of a major road--as well as discretionary federal 
programs.[Footnote 2] The compact's fiscal procedures subsidiary 
agreement[Footnote 3] requires an annual audit of Palau's use of 
compact funds. The agreement also requires Palau to submit economic 
development plans every 5 years, as well as annual reports on, among 
other things, its implementation of these plans. The agreement also 
requires the U.S and Palau governments to hold annual economic 
consultations to review Palau's progress toward self-sufficiency. 
Additionally, the compact's subsidiary trust fund agreement requires 
the U.S. and Palau governments to consult regarding Palau's trust fund 
every 5 years. The Department of the Interior's (Interior) Office of 
Insular Affairs (OIA) has primary responsibility for monitoring and 
coordinating all U.S. assistance to Palau, and the Department of State 
(State) is responsible for government-to-government relations.

Direct assistance provided under title two of the compact is due to 
expire on September 30, 2009. At that time, Palau's annual withdrawals 
from its trust fund can increase from $5 million to $15 million. 
[Footnote 4] The compact's federal programs and services agreement 
will, unless renewed or extended, also expire on September 30, 2009, 
ending the provision to Palau of three federal services-- postal, 
weather, and aviation. The compact mandates that the governments of the 
United States and Palau review the terms of the compact and its related 
agreements in 2009 and that any modifications be made by mutual 
agreement.

You asked us to examine (1) the provision of compact and other U.S. 
assistance to Palau in 1995-2009, (2) Palau's and U.S. agencies' 
efforts to provide accountability over Palau's use of federal funds in 
1995-2006, and (3) Palau's prospects for achieving economic self- 
sufficiency. In addition, we provide information on amendments made to 
the United States' compacts with the Federated States of Micronesia 
(FSM) and the Republic of the Marshall Islands (RMI) in 2003 and the 
relevancy of these amendments for Palau (see app. II).

To address our objectives, we reviewed Palau's compact annual reports, 
Palau's financial statements and internal control reports for 1995- 
2006, compact road project documentation, and economic studies. We 
interviewed officials from Interior; State; and the Departments of 
Agriculture (USDA), Defense (DOD), Education (Education), Health and 
Human Services (HHS), Homeland Security, Labor, and Transportation 
(DOT). In addition, we interviewed officials from the Federal Aviation 
Administration (FAA), the U.S. Postal Service (USPS), the National 
Weather Service (NWS)[Footnote 5] and the U.S. Army Corps of Engineers 
(USACE), as well as economic experts from the International Monetary 
Fund (IMF) and the Asian Development Bank (ADB). In Palau, we 
interviewed government officials from a range of ministries, including 
the ministries of Finance, Health, Education, and Resources and 
Development, and the Office of the Public Auditor. We also met with 
private sector representatives and nongovernmental organizations in 
Palau, and we spoke with Palau's external auditor. We inspected the 
compact road and viewed infrastructure improvements to Palau's airport 
funded by FAA's Airport Improvement Program. We conducted this 
performance audit from October 2007 to June 2008 in accordance with 
generally accepted government auditing standards. Those standards 
require that we plan and perform the audit to obtain sufficient, 
appropriate evidence to provide a reasonable basis for our findings and 
conclusions based on our audit objectives. We believe that the evidence 
obtained provides a reasonable basis for our findings and conclusions 
based on our audit objectives. Appendix I provides more details on our 
objectives, scope, and methodology.

Results in Brief:

U.S. aid to Palau in 1995-2009--compact direct assistance,[Footnote 6] 
compact federal services, compact road construction, and discretionary 
federal programs--is expected to exceed $852 million.[Footnote 7] 
Compact direct assistance, providing general budgetary support for 
Palau's government operations, will account for $411 million, or 48 
percent of the assistance provided. Compact federal services--postal, 
weather, and aviation--will account for about $25 million, or 3 percent 
of the assistance, and compact road construction accounted for $149 
million, or 17 percent of the assistance. Palau's receipt of 
discretionary federal program assistance will account for another $267 
million, or 31 percent of the total assistance provided. For 1995-2006, 
five U.S. agencies--Education, HHS, Interior, DOD, and DOT--contributed 
the majority of discretionary federal program assistance to Palau.

Despite limited capacity to address persistent internal control 
weaknesses, Palau made progress in providing financial accountability 
and met most of the compact's and related agreements' accountability 
requirements; however, OIA provided limited monitoring of Palau's 
accountability for compact assistance. Palau's single audit reports for 
1995-2006 show that it made progress in financial accountability by 
improving its timeliness in submitting the audit reports and improving 
the reliability of its financial statements. At the same time, the 
reports show persistent weaknesses in Palau's internal controls over 
financial reporting; the reports also indicate that Palau has not 
complied with all federal award requirements and show persistent 
weaknesses in Palau's internal control over compliance with these 
requirements. Although Palau has developed plans to correct these 
weaknesses, Palau's controller and Palau's external auditor said that 
limited capacity in financial accounting resources and expertise limits 
Palau's ability to execute these plans in a timely way. These 
weaknesses put Palau at risk of being unable to sustain its 
improvements in financial accountability and to operate a major federal 
program within applicable requirements. Palau met the majority of the 
compact's and related agreements' accountability requirements, such as 
submitting annual reports and economic development plans. OIA and State 
officials, as well as officials from the government of Palau, reported 
that they participated in the economic consultations required by the 
fiscal procedures agreement but that the meetings were not held 
annually. Moreover, U.S. and Palau officials acknowledged that the 
required trust fund consultations were not held at all. According to 
OIA officials, OIA uses Palau's single audit results and compact annual 
reports to monitor Palau's use of compact funds but views its oversight 
role as limited.

Palau's prospects for economic self-sufficiency depend on four key 
factors: levels of continued U.S. assistance, the availability and 
value of trust fund withdrawals, fiscal reform to reduce Palau's 
dependence on these withdrawals, and private sector growth through an 
improved business environment.

* U.S. assistance. Given the $10 million scheduled increase in Palau's 
annual trust fund withdrawals in 2010, the expiration of $13.3 million 
in U.S. compact direct assistance at the end of 2009 will likely cause 
a net decline of less than 4 percent in Palau's national government 
revenues. However, potential increases or reductions in future levels 
of discretionary federal programs--estimated at $11.9 million in 2009-
-could have a significant fiscal impact. In addition, unless the 
federal programs and services agreement is extended by the U.S. and 
Palau governments, Palau will lose postal, weather, and aviation 
services that are estimated to cost U.S. agencies almost $1.6 million 
in 2009.

* Trust fund withdrawals. A compounded annual return of at least 8.1 
percent will allow Palau to withdraw $15 million per year from its 
trust fund for the planned 35 years. From 1995 through March 2008, the 
Palau trust fund earned a compounded return of 9 percent.[Footnote 8] 
However, market volatility makes it possible that the trust fund will 
be depleted after 2016 even with a favorable long-term average rate of 
earnings. In addition, future inflation will cause the withdrawals to 
lose value over time.

* Fiscal reform. To decrease its long-term reliance on trust fund 
financing, Palau will require fiscal reforms aimed at closing the gap 
between its revenues and expenditures. Specifically, experts suggest 
that Palau improve its tax income by addressing the problem of weak 
administration and an inefficient income and business tax structure and 
reduce its expenditures through lowering the public sector wage bill.

* Private sector growth. To promote private sector growth, Palau will 
need to improve its business environment. Currently, restrictive 
foreign investment regulations and practices, deficient financial 
oversight, inadequate access to land, and an inability to attract 
skilled workers raise private sector costs and weaken investment 
incentives.

To improve Palau's ability to sustain its improvements in financial 
reporting and address its internal control weaknesses, we recommend 
that the Secretary of the Interior direct the Office of Insular Affairs 
to formally consult with the government of Palau regarding Palau's 
financial management challenges and target future technical assistance 
toward building Palau's financial management capacity.

We provided a draft of this report to the Secretary of the Interior, 
the Secretary of State, and the government of Palau. The Department of 
the Interior agreed with our report and recommendation and said that it 
had begun making plans to implement the recommendation. The government 
of Palau also agreed with our report and recommendation. The Department 
of State did not comment on the report. In addition, we received 
technical comments from USDA, Education, and Homeland Security, as well 
as FAA, NWS, USPS, and the USACE.

Background:

U.S. relations with Micronesia began during World War II, when the 
United States ended Japanese occupation of the region. In 1947, the 
United Nations assigned the United States administering authority over 
the Trust Territory of the Pacific Islands, which included Palau and 
other Micronesian island districts. During its administration of the 
trust territory, the United States aided these islands by, among other 
things, building roads, hospitals, and schools; extending eligibility 
for U.S. federal programs; and supporting government operations. The 
trustees eventually sought various forms of independence and today 
comprise four island jurisdictions: the Commonwealth of the Northern 
Mariana Islands, an insular area under the sovereignty of the United 
States, and three Freely Associated States--the Federated States of 
Micronesia (FSM), the Republic of the Marshall Islands (RMI), and the 
Republic of Palau.[Footnote 9] Palau adopted its own constitution in 
1981, and the governments of the United States and Palau concluded a 
Compact of Free Association in 1986, similar to compacts that the 
United States had entered into with the FSM and the RMI. The compact 
entered into force on October 1, 1994, concluding Palau's transition 
from trusteeship to independence. As a sovereign nation, Palau conducts 
its own foreign relations. Palau is a member of the United Nations and 
has bilateral relations with more than 40 countries, including the 
United States and Japan, as well as the European Union. Palau also has 
diplomatic relations with Taiwan.

Palau's territory of about 190 square miles includes 8 main islands and 
more than 250 smaller islands. As the westernmost cluster of the 
Caroline Islands in the North Pacific Ocean, Palau is located 
approximately 500 miles southeast of the Philippines (see fig. 1). 
Roughly 20,000 people live in Palau, although more than one-quarter of 
the population is non-Palauan. The majority of the population lives in 
the single urban center, Koror, although the capital was officially 
moved in 2006 to Meleokeok, on Babeldaob, Palau's largest island. 
Meleokeok is the seat of Palau's national government, which has an 
executive branch, a legislative branch, and a judicial branch. The 
country is divided into 16 states, each with its own governor and 
legislature.

Figure 1: Location and Map of Palau: 

This figure is a map of the Far East with an inset map sowing the 
specific location of Palau. 

[See PDF for image] 

Source: GAO, Map Resources (map). 

[End of figure]

Palau's economy is heavily dependent on its tourism sector and 
substantial foreign aid from the United States, Japan, and Taiwan. 
Since 1994, Palau's economy has grown at a real annual average of 3 
percent; in 2006, Palau's gross domestic product (GDP) was about $154 
million and its GDP per capita was about $7,500.[Footnote 10] 
International visitor arrivals--more than 82,000 in 2006--contributed 
about $97 million to the economy. Similar to many small island 
economies, Palau also receives significant foreign aid, which finances 
a large public sector. In 2006, Palau's national government 
expenditures were $89 million, equivalent to 58 percent of its GDP, and 
the United States and other donors provided grants totaling $44 
million, equivalent to 28 percent of Palau's GDP (see fig. 2).[Footnote 
11] While 2006 national government expenditures exceeded total 
revenues, Palau also has access to financing through interest earned on 
government assets and allowed annual withdrawals on the compact- 
provided trust fund. Palau's government employs about one-third of all 
workers, and the national government wage bill constituted an average 
40 percent of its total expenditures from 2000 to 2006. Palau's private 
sector relies heavily on foreign workers, mostly from the Philippines; 
since 1994, foreign workers[Footnote 12] have grown to account for half 
of Palau's total labor force. Because many of these foreign workers 
send wage income back to their home nations, the annual net outflow of 
remittances from Palau equaled an estimated 5.5 percent of its 2005 
GDP. (For further statistics on Palau's economy and assistance level as 
it compares to other compact nations, see app. III.)

Figure 2: Palau National Government Expenditures and Revenues: 

This figure contains two pie-charts with associated data tables. The 
following data is depicted: 

2000-2006 Average Expenditure by Type: 

Wage bill: 40%; 
Capital: 21%; 
Other Operating: 39%. 

2006 Expenditure Level: 

Capital: 
Dollars in millions: $22.7; 
Percentage of GDP: 15%. 

Wage bill: 
Dollars in millions: $33.2; 
Percentage of GDP: 22%. 

Other Operating: 
Dollars in millions: $33.4; 
Percentage of GDP: 22%. 

Total: 
2000-2006 Average Revenue by Source: 
Taxes: 39%; 
U.S. Assistance: 35%; 
Other donor assistance: 15%; 
Other domestic: 15%. 

2006 Revenue Level: 

U.S. Assistance: 
Dollars in millions: $31.5; 
Percentage of GDP: 20%. 

Other donor assistance: 
Dollars in millions: $12.8; 
Percentage of GDP: 8%. 

Taxes: 
Dollars in millions: $29.4; 
Percentage of GDP: 19%. 

Other domestic: 
Dollars in millions: $9.6; 
Percentage of GDP: 6%. 

Total: 
Dollars in millions: $83.3; 
Percentage of GDP: 54%. 

Source: GAO estimates based on Palauï¿½s single audit reports. 

[See PDF for image]

Notes:

GDP = gross domestic product.

Figures and tables exclude: (a) component units, such as the Palau 
Community College; (b) in-kind foreign assistance, such as compact 
federal services; and (c) annual net financing, such as Palau's $5 
million trust fund withdrawal from 2002-2006, to pay for the gap 
between revenues and expenditures. Net financing is excluded as a 
revenue source given that the trust fund was designed to provide Palau 
with financing only until 2044, in addition to the market volatility 
associated with investment earnings.

"Other operating" expenditures include those for goods and services and 
"Other domestic" revenues include fees and charges, licenses, permits, 
and other direct revenues.

All years cited are fiscal years (Oct. 1-Sept. 30). All dollar amounts 
are in current (i.e., nominal) dollars. 

[End of figure] 

Compact of Free Association:

The Compact of Free Association between Palau and the United States 
became effective on October 1, 1994,[Footnote 13] with the U.S. 
interest of promoting Palau's self-sufficiency and economic 
advancement. It also established certain national security objectives 
for Palau and the United States. The compact requires the United States 
to provide a 15-year term[Footnote 14] of direct assistance and to set 
up a trust fund with the goal of producing an annual distribution of 
$15 million for 35 years, starting in 2010. The compact also includes 
certain security and defense provisions between the two countries, 
which are binding until 2044 unless amended by mutual consent. Other 
provisions of the compact continue in perpetuity unless mutually 
terminated by the two countries or individually by Palau or the United 
States. The compact mandates that the U.S. and Palau governments 
formally review the terms of the compact and its related agreements on 
the 15th, 30th, and 40th anniversaries of the effective date of the 
compact and mutually agree to any alterations. The first mandated 
review will take place in 2009.

Table 1: Key Provisions of the Palau Compact of Free Association and 
Related Subsidiary Agreements:

Compact section: Title one: Government Relations; 
Description of key provisions: Sovereignty: Establishes Palau as a self-
governing nation with the capacity to conduct its own foreign affairs; 
Immigration privileges: Provides Palauan citizens with certain 
immigration privileges, such as the rights to work and live in the 
United States indefinitely and to enter the United States without a 
visa or passport. 

Compact section: Title two: Economic Relations; 
Description of key provisions: Compact direct assistance: 15-year term 
of budgetary support for Palau, including direct assistance for current 
account operations and maintenance, and for specific needs such as 
energy production, capital improvement projects, health, and education; 
Requires the United States to set up a trust fund for Palau. This 
assistance expires in 2009. Compact road: Requires the United States to 
build a road system for Palau (the "compact road"). Compact federal 
services: Requires the United States to make available certain federal 
services and related programs to Palau, such as postal, weather, and 
aviation services. The compact federal programs and services agreement-
establishing the legal status of programs and related services, federal 
agencies, U.S. contractors, and personnel of U.S. agencies implementing 
both compact federal services and discretionary federal programs in 
Palau-expires in 2009. Accountability of compact funds: Requires Palau 
to report annually on its use of compact funds. Requires the U.S. 
government, in consultation with Palau, to implement procedures for 
periodic audit of all grants and other assistance. 

Compact section: Title three: Security and Defense Relations; 
Description of key provisions: Establishes that the United States has 
full authority and responsibility for security and defense matters in 
or relating to Palau. Forecloses Palau to the military of any other 
nation except the United States. The United States may establish 
defense sites in Palau and has certain military operating rights. 
Security provisions specified in the subsidiary status of force 
agreement[A] are binding until 2044, 50 years from the effective date 
of the compact, or until the termination of title three of the compact, 
whichever is longer.

Compact section: Title four: General Provisions; 
Description of key provisions: Establishes general provisions regarding 
approval and effective date of the compact, conference and dispute 
resolution procedures, amendment and review requirements, and compact 
termination procedures.

Source: GAO analysis of the Compact of Free Association.

Note: The compact's subsidiary agreements relate to specific titles of 
the compact; in many cases, they contain implementing details of 
compact provisions.

[A] Status of Forces Agreement Concluded Pursuant to Section 323 of the 
Compact of Free Association. 

[End of table] 

Other U.S. Assistance to Palau:

In addition to the U.S. assistance provided under the terms of the 
compact, U.S. agencies--Education, HHS, and Interior, among others-- 
extend discretionary federal programs to Palau as authorized by U.S. 
legislation, and with funding appropriated by Congress for the 
programs. The federal programs and services agreement--which 
establishes the legal status of programs and related services, federal 
agencies, U.S. contractors, and personnel of U.S. agencies implementing 
both compact federal services and discretionary programs in Palau-- 
expires in 2009.

Key Compact and Related Agreements Accountability Requirements:

The compact's fiscal procedures agreement states that the U.S. 
government has the authority and responsibility to audit all compact 
funds[Footnote 15] and requires Palau to submit audit reports each year 
on its use of compact funding, within the meaning of the Single Audit 
Act.[Footnote 16] Single audit reports provide key information about 
Palau's financial management and reporting and are an important control 
used by federal agencies for overseeing and monitoring the use of 
federal grants.[Footnote 17] These reports are due at the end of the 
third quarter following the end of the fiscal year under review. 
Interior is designated as the cognizant agency with respect to Palau's 
single audits;[Footnote 18] OIA carries out the responsibilities 
associated with that designation. Interior's Office of the Inspector 
General (OIG) also has audit oversight responsibilities for federal 
funds in Palau. In addition, Palau's Office of the Public Auditor has 
authority to review the government of Palau's use of U.S. federal grant 
funds.[Footnote 19]

In addition, the compact and related agreements require the Palau and 
U.S. governments to meet other reporting and consultation requirements 
to provide accountability over the use of compact funds.[Footnote 20] 
An executive order regarding the management of the compact assigns 
Interior responsibility for monitoring and coordinating assistance 
provided under the compact and assigns State responsibility for 
government-to-government relations.[Footnote 21]

* Economic development plans. Palau must submit an overall economic 
development plan to the U.S. government every 5 years, identifying the 
planned annual expenditure of compact assistance.[Footnote 22] The U.S. 
government is required to review each plan in order to ascertain 
compliance and consistency with the requirements of the compact, to 
assist the government of Palau in identifying and evaluating 
appropriate goals and objectives, and to determine what U.S. government 
assistance might be made available to assist Palau in implementing the 
plan.

* Annual reports. Palau must submit an annual report to the U.S. 
government each year describing Palau's economic activities and 
progress in the previous year. The annual reports are required to 
describe Palau's implementation of its overall economic development 
plan and must include specific information on the use of compact funds 
and comprehensive information on Palau's trust fund.

* Annual economic consultations.[Footnote 23] The U.S. and Palau 
governments must consult annually regarding the substance of Palau's 
annual reports. Specific topics to be discussed include all matters 
covered in the annual reports, Palau's expenditure of compact funding, 
and recommendations for issues to be addressed in future annual reports.

* Trust fund consultations. Beginning in 2000, the U.S. and Palau 
governments must consult every 5 years to discuss the performance of 
the trust fund and to evaluate the relationship between the performance 
of the trust fund and the condition of Palau's operating expenditures. 
The two governments are required to take mutually-agreed upon action to 
resolve any issues identified.

U.S. Assistance to Palau in 1995-2009 Is Projected at More Than $852 
Million:

The United States' cost of providing assistance to Palau in 1995-2009 
is projected to exceed $852 million. This assistance consists of 
compact direct assistance, compact federal services, compact road 
construction, and discretionary federal programs. The first three forms 
of assistance--compact direct assistance, compact federal services, and 
compact road construction--are mandated by the compact and represent 
approximately 48 percent, 3 percent, and 17 percent, respectively, of 
total projected U.S. assistance for 1995-2009. U.S. agencies provide 
the remaining 31 percent of total assistance through discretionary 
federal programs[Footnote 24] (see fig. 3).

Figure 3: U.S. Assistance to Palau 1995-2009 (projected): 

This figure is a pie-chart depicting the following data: 

(Dollars in millions): 

Compact direct assistance: 48% ($411.0); 
Discretionary federal programs: 31% ($266.7); 
Compact road: 17% ($149.0); 
Compact federal services: 3% ($25.3). 

Source: GAO analysis.

[See PDF for image]

Notes:

Figure shows funding for fiscal years (Oct. 1-Sept. 30). All dollar 
amounts are in current (i.e., nominal) dollars.

GAO's calculations of direct compact assistance and the compact road 
are based on Interior's Office of Insular Affairs' actual and estimated 
payments to Palau for 1995-2009, as reported in its budget 
justification to Congress for 2009. Compact federal services are 
estimates of past and future expenditures by the NWS, USPS, and the 
FAA. The calculation of estimated discretionary federal programs is the 
sum of U.S. agency program expenditures as reported in single audits 
for 1995-2006 for the Palau national government and for 1997-2006 for 
the Palau Community Action Agency and the Palau Community College. GAO 
projected U.S. agency program expenditures for 2007-2009. To this, we 
added an estimated cost of DOD's Civic Action Teams for 1995-2009. 
Estimated and projected federal program expenditures do not include the 
value of U.S. loans to Palau. For more details, see app. I. 

[End of figure] 

Compact Direct Assistance:

Compact direct assistance accounts for roughly half of projected U.S. 
assistance to Palau in 1995-2009, amounting to more than $411 million. 
[Footnote 25] This assistance flows as a direct transfer payment to the 
government of Palau. The compact specifies general purposes for these 
funds but gives the Palau government broad discretion regarding the use 
of these funds.[Footnote 26] Some direct assistance is provided 
annually for a period of 15 years from the effective date of the 
compact (i.e., 1995-2009). However, more than half of the direct 
assistance was provided in the first 3 years of the compact (see app. 
VII), allowing Palau to invest some of these funds to generate 
additional income. All compact direct assistance will terminate in 
2009. Table 2 details the compact's provisions for direct assistance.

Table 2: Compact Direct Assistance Provisions and Amounts, 1995-2009:

Compact section: 211(a); 
Description: Current account operations and maintenance; $12 million 
annually for 10 years (1995-2004) and $11 million annually for the next 
5 years (2005-2009). Beginning in 1999, $5 million of this amount shall 
come from the trust fund set up in 211(f); 
Amount provided 1995-2009 (projected): $120 million.

Compact section: 211(b); 
Description: Energy production self-sufficiency; $2 million annually 
for 14 years (1995-2008); 
Amount provided 1995-2009 (projected): $28 million.

Compact section: 211(c); 
Description: Communications; $150,000 annually for 15 years (1995-2009) 
for current account operations and maintenance of communications 
systems plus a sum of $1.5 million in 1995 for acquiring communications 
hardware or for another operating or capital account activity as Palau 
selects; 
Amount provided 1995-2009 (projected): $3.75 million.

Compact section: 211(d); 
Description: Maritime zone surveillance and enforcement, health 
programs, and postsecondary scholarship fund; $631,000 annually for 15 
years (1995-2009); 
Amount provided 1995-2009 (projected): $9.5 million.

Compact section: 211(e); 
Description: Maritime zone surveillance and enforcement start-up 
activities; One-time contribution of $666,800; 
Amount provided 1995-2009 (projected): $0.7 million.

Compact section: 211(f); 
Description: Trust fund; $66 million in 1995 plus $4 million in 1997; 
Amount provided 1995-2009 (projected): $70 million.

Compact section: 212(b); 
Description: Capital account purposes; One-time contribution of $36 
million in 1995; 
Amount provided 1995-2009 (projected): $36 million.

Compact section: 213; 
Description: Defense use impact fund; One-time contribution of $5.5 
million in 1995; 
Amount provided 1995-2009 (projected): $5.5 million.

Compact section: 215; 
Description: Inflation adjustment; Yearly adjustment of amounts 
provided in sections 211(a), 211(b), 211(c), and 212(b); 
Amount provided 1995-2009 (projected): $98.9 million.

Compact section: 221(b) and federal programs and services agreement; 
Description: Special block grants for health and education; $2 million 
annually for 15 years (1995-2009), $4.3 million in 1995, $2.9 million 
in 1996, and $1.5 million in 1997; 
Amount provided 1995-2009 (projected): $38.7 million.

Compact section: Total direct assistance; 
Amount provided 1995-2009 (projected): $411 million.

Source: GAO analysis of the Compact of Free Association and OIA budget 
justification 2009.

Note: All years cited are fiscal years (Oct. 1-Sept. 30). All dollar 
amounts are in current (i.e., nominal) dollars. 

[End of table] 

Palau reported the following uses of compact direct assistance in 1995- 
2006:

* More than one-quarter of direct assistance was provided to Palau 
under compact section 211(a) as annual budgetary support and used for 
general government operations. According to its compact annual reports, 
Palau distributed its 211(a) funds for uses such as supporting its 
executive, legislative, and judicial branches; independent agencies; 
and in block grants to states. In 2006, for example, Palau allocated $4 
million to its executive branch; $1 million to its independent 
agencies, which includes its Office of the Public Auditor and Office of 
the Special Prosecutor; and $1 million to other agencies and programs, 
which include components such as its Coral Reef Center.

* The United States provided the entire $28 million of section 211(b) 
funds to Palau in 1995, when the compact went into effect,[Footnote 27] 
enabling Palau to accrue investment earnings on the base sum. According 
to Palau's compact annual reports, the government used 211(b) funds on 
a range of projects to achieve energy self-sufficiency, such as paying 
off its debt on its central power station and improving power systems 
in outlying states. Palau reports that it achieved electrification for 
all of its 16 states by 1999; states receive electricity from one of 
Palau's two main power stations or from the island states' alternate 
sources.

* Palau used section 211(c) assistance primarily for public 
broadcasting operations and 211(d) and 211(e) funds for purposes such 
as patrol boat operations, education scholarships, and medical supplies.

* Section 211(f) of the compact required the United States to establish 
a trust fund for Palau with an initial investment of $70 million by the 
compact's third year. In accordance with terms of the trust fund 
agreement, since 1999, $5 million of annual 211(a) assistance has been 
available from the trust fund, although Palau did not begin taking this 
disbursement until 2002.

* As specified in section 212(b), Palau received $36 million in fiscal 
year 1995 for capital account purposes. Funding was spent for purposes 
such as improvements to Palau's water system and national roads; 
rehabilitation of a power plant and schools; and construction of a 
national gymnasium, four health dispensaries, and education facilities. 
Palau also passed some of this funding to state governments for state- 
directed capital improvement projects.

* Funding for section 211(a), as well as the assistance granted in 
sections 211(b), 211(c), and 212(b), was increased because of the 
inflation adjustment dictated in section 215.[Footnote 28] Inflation 
adjustment for these four sections will account for an additional $99 
million in assistance by 2009.

* In 1997-2006, the Palau national government transferred the $2 
million provided annually under section 221(b) of the compact for 
health and education purposes to the Palau Community College for its 
operations.

Compact Federal Services:

The compact provides for federal postal, weather, and aviation services 
in Palau at a level equivalent to the services provided the year before 
the compact was implemented.[Footnote 29] The federal programs and 
services agreement describes the provisions of each of these services. 
This agreement remains in force for 15 years from the effective date of 
the compact; as a result, U.S. provision of these three federal 
services will expire in 2009 unless the agreement is renewed or 
extended. U.S. agencies providing these services--USPS, NWS, and FAA-- 
incur costs in doing so, but in some cases, the United States receives 
a reciprocal benefit.

Table 3: Compact Federal Services, 1995-2009:

Federal service: Postal service; 
U.S. agency providing service: U.S. Postal Service; 
Estimated expenditures by U.S. agency providing service 1995-2009 
(projected): $12.3 million.

Federal service: Weather service; 
U.S. agency providing service: National Weather Service; 
Estimated expenditures by U.S. agency providing service 1995-2009 
(projected): $8.6 million.

Federal service: Aviation service; 
U.S. agency providing service: Federal Aviation Administration; 
Estimated expenditures by U.S. agency providing service 1995-2009 
(projected): $4.4 million.

Federal service: Total; 
Estimated expenditures by U.S. agency providing service 1995-2009 
(projected): $25.3 million.

Source: GAO analysis of estimates provided by USPS, NWS, and FAA.

Note: All years cited are fiscal years (Oct. 1-Sept. 30). All dollar 
amounts are in current (i.e., nominal) dollars. 

[End of table] 

USPS conveys mail[Footnote 30] between the United States and Palau and 
offers other services such as Priority Mailï¿½, cash-on-delivery, and 
postal money orders. USPS charges U.S. domestic postal rates[Footnote 
31] for mail sent between the United States and Palau. The government 
of Palau retains the revenue from stamps purchased in Palau, while USPS 
retains revenue from stamps purchased in the United States. USPS 
officials said that the postage charged does not reflect the real cost 
of conveying mail to Palau, especially with rising transportation 
costs.[Footnote 32] USPS is reimbursed by Interior for providing postal 
services to Palau; however, according to USPS officials, the amount 
reimbursed is less than the total cost of service. This loss is reduced 
by USPS's revenue collected on stamps for Palau-bound mail purchased in 
the United States. In addition to transporting mail, USPS provides 
technical assistance to Palau's postal service and has made several 
donations of used equipment, such as mail trucks.

NWS reimburses Palau for the cost of operating its weather station in 
Palau. The weather station in Palau performs upper air observations 
twice daily with a weather balloon as well as additional weather 
observations on request. The station and the equipment are maintained 
by Palauan staff, which includes two meteorologists whose professional 
training was sponsored by NWS. The weather forecasts produced by the 
weather station are essential to Palau's airport operations. The 
station's observations are important to NWS in helping to predict 
cyclones and other violent weather traveling eastward from Palau toward 
U.S. territories such as Guam.

FAA provides aviation services[Footnote 33] to Palau, including en- 
route air traffic control from the mainland United States, flight 
inspection of airport navigation aids, and technical assistance and 
training.

Compact Road:

The compact required the United States to build a road system in Palau 
based on specifications mutually agreed with the government of Palau. 
Interior's OIA budgeted $149 million for the project. While the compact 
required the road to be completed by October 1, 2000, the project 
incurred several planning and construction delays and was not completed 
until October 1, 2007. When the road was completed, Palau accepted 
responsibility for its operation and maintenance. Palau has made 
efforts to maintain the road; however, both U.S. and Palau officials 
have concerns regarding Palau's ability to maintain the road in a 
condition that will allow for the desired economic development. See 
appendix V for more information on the compact road.

Discretionary Federal Programs:

Discretionary federal programs are projected to contribute 
approximately $266.7 million, or 31 percent, of total U.S. assistance 
to Palau between 1995 and 2009. Discretionary federal programs, which 
include federal grants, in-kind services, and loans provided by U.S. 
agencies, assist Palau in areas such as education, health, 
infrastructure improvement, and telecommunications. In 1995-2006, more 
than 14 U.S. agencies provided Palau federal grants and other in-kind 
services worth approximately $203 million.[Footnote 34] Five agencies 
contributed the majority of discretionary assistance to Palau (see fig. 
4). Most of the federal grants awarded to Palau go to the national 
government; two other recipients are the Palau Community College and 
the Palau Community Action Agency, a nonprofit organization. Palau's 
national government spent approximately $132 million, or 73.6 percent 
of the $180 million, of the federal grants awarded to these three 
entities in 1995-2006.

Figure 4: Top Five U.S. Agencies' Expenditures in Palau, 1995-2006: 

This figure is a pie-chart depicting the following data: 

Top Five U.S. Agencies' Expenditures in Palau, 1995-2006: 
Education: $28% ($56.2 million); 
HHS: 25% ($51.6 million); 
Interior: 19% ($39.1 million); 
DOD: 12% ($23.8 million); 
Other agencies: 10% ($19.8); 
DOT: 6% ($12.9). 

Source: GAO analysis. 

[See PDF for image]

Notes:

Figure shows expenditures for fiscal years (Oct. 1-Sept. 30). All 
dollar amounts are in current (i.e., nominal) dollars.

For all agencies, with the exception of DOD, our analysis used 
expenditure information reported in the single audits from the Palau 
national government, the Palau Community College, and the Palau 
Community Action Agency. GAO estimated DOD's expenditures for its Civic 
Action Team operating costs based on information provided by DOD 
officials. This figure does not include the value of other in-kind 
assistance provided by DOD or any other U.S. agency and it does not 
include the value of U.S. loans extended to Palau. 

[End of figure] 

* The U.S. Department of Education provided federal grants to both the 
national government of Palau and to the Palau Community College, an 
accredited, postsecondary vocational and academic institution.[Footnote 
35] These grants provided funding for a number of education services, 
including special and adult education programs, teacher training and 
curriculum development, and postsecondary financial aid. For example, 
approximately 550 of the 600 students at the Palau Community College 
receive Pell Grants, which were worth approximately $2.2 million in 
2006. Other programs extended to Palau include Education's TRIO 
programs: Upward Bound, Upward Bound Math and Science, and Talent 
Search.[Footnote 36]In 2006, 110 students participated in the Upward 
Bound program, which was worth approximately $360,000.[Footnote 37]

* HHS supported Palau's Ministry of Health, particularly its Bureau of 
Public Health, with grant programs that fund a health clinic program, a 
family planning program, and immunization programs. HHS also provided 
federal grants to the Palau Community Action Agency, a private, 
nonprofit organization that runs the Head Start program in Palau. 
[Footnote 38] According to Palau government officials, children are 
required to begin their education at 6 years of age; Head Start 
provides the primary early-childhood education and health program for 
children aged 3 to 5 years. The Palau Community Action Agency runs 13 
Head Start education centers throughout Palau and receives funding for 
an enrollment of 509 children.

* Interior's OIA has provided a number of grants to Palau, including 
funding to cover the cost of Palau's single audit and technical 
assistance grants to provide training and support to finance and budget 
officials, the Public Auditor's office, and the Bureau of Lands and 
Survey. In addition, Interior has provided funds for emergency repairs 
to the national hospital and in support of infrastructure development 
through the Airport Improvement Program.

* DOD provided in-kind service assistance to Palau through its Civic 
Action Team (CAT). The CAT program consists of teams of 13 service men 
and women, primarily engineers, stationed in Palau for 6-month 
rotations. These teams provide assistance in the following four areas: 
(1) construction, (2) apprentice training, (3) community relations, and 
(4) a medical program.

* DOT provided a $26 million, 4-year grant (2003-2007) to Palau as part 
of the FAA's Airport Improvement Program. It enhanced the safety and 
capability of Palau's airport by rehabilitating the runway, purchasing 
fire fighting equipment, and installing perimeter security fencing.

* Ten other agencies extended federal grants to Palau in 1995-2006. For 
example, the Department of Labor provided Workforce Investment Act 
funds to help finance job training and career development programs, and 
USDA extended forestry grant programs.

See appendix VI for more information regarding selected discretionary 
federal programs.

In addition to the federal grants and DOD CAT program costs enumerated 
in figure 4, U.S. agencies have provided a range of other assistance 
[Footnote 39] to Palau to assist with maritime surveillance, disaster 
relief, education, and telecommunications. For example, DOD provided 
surveillance assistance to Palau to facilitate and enhance joint 
fisheries surveillance and enforcement. According to agency officials, 
DOD also has the authority to assist with natural disasters in Palau. 
The Peace Corps has had a presence in Palau since 1966 and currently 
has 13 volunteers stationed there to assist in education programs 
primarily at public schools throughout the country.[Footnote 40] The 
United States also has extended development loans to Palau.[Footnote 
41] USDA Rural Development provided subsidized loans to Palau through 
its utilities and housing programs. Through the utilities program, a 
$39 million loan was provided in 1992 to the Palau National 
Communications Corporation to improve the telecommunications 
infrastructure in Palau. (For more information about this loan, see 
app. VI.) USDA's Rural Housing program provided 102 loans, worth over 
$3.1 million, to individuals and families for the purchase or repair of 
their home in 1998-2007.

Palau Made Progress in Accountability but Has Limited Capacity to 
Address Internal Control Weaknesses; Interior's Oversight Has Been 
Limited:

Palau's more recent single audit reports show that it made progress in 
financial accountability by improving its timeliness in submitting the 
audit reports. The recent single audit reports also show that Palau has 
improved the reliability of its financial statements. However, the 
reports show persistent weaknesses in Palau's internal control over 
financial reporting. Additionally, the reports indicate that Palau has 
not complied with all federal award requirements and has weaknesses in 
its internal control over compliance with federal award requirements. 
However, limited capacity in financial accounting resources and 
expertise hinders Palau's ability to address these weaknesses in a 
timely way. As a result, Palau is at risk of being unable to sustain 
its improvements in financial accountability and to operate a major 
federal program according to applicable requirements. Palau met the 
majority of the compact's and related agreements' reporting 
requirements for accountability over compact funds, but Palau and the 
U.S. government did not meet all of the consultation requirements. 
Interior's oversight of Palau's accountability for assistance provided 
under the compact was limited.

Palau's Single Audits Show Improved Financial Accountability but Also 
Persistent Internal Control Weaknesses that Palau Has Limited Capacity 
to Address:

The Palau national government has improved its financial accountability 
in terms of the timeliness of its single audit report submissions. In 
addition, Palau's recent single audit reports show progress in 
improving the reliability of its financial statements. However, the 
reports also show persistent weaknesses in Palau's internal control 
over financial reporting. In addition, Palau's single audit reports 
show long-standing weaknesses in its internal control over compliance 
with laws and regulations governing federal awards. Although Palau has 
developed plans to correct its internal control weaknesses, its 
capacity to execute these plans in a timely manner is limited. As a 
result, Palau is at risk of being unable to sustain its improved 
financial accountability.

Palau's Timeliness in Submitting Single Audit Reports Has Improved:

Palau's timeliness in submitting single audit reports has improved in 
recent years. Although Palau submitted its single audit reports for 
1998-2004 after the established deadlines,[Footnote 42]Palau submitted 
reports for 2005 and 2006 on time.[Footnote 43] (See table 4.) Timely 
submission of single audit reports gives U.S. agencies current 
knowledge of the Palau government's ability to account for federal 
grant monies received and current knowledge of the government's 
internal control and compliance challenges.

Table 4: Single Audit Act Report Submissions, 1995-2006:

Year: 1995; 
Number of months late: N/A[A].

Year: 1996; 
Number of months late: N/A[A].

Year: 1997; 
Number of months late: 0.

Year: 1998; 
Number of months late: 2.

Year: 1999; 
Number of months late: 3.

Year: 2000; 
Number of months late: 29.

Year: 2001; 
Number of months late: 4.

Year: 2002[B]; 
Number of months late: 23.

Year: 2003; 
Number of months late: 11.

Year: 2004; 
Number of months late: 6.

Year: 2005; 
Number of months late: 0.

Year: 2006; 
Number of months late: 0.

Sources: OMB Circular No. A-133, auditors' reports, Federal Audit 
Clearinghouse, and GAO analysis.

Note: All years cited are fiscal years (Oct. 1-Sept. 30).

[A] The Federal Audit Clearinghouse started receiving the Single Audit 
form (SF-FAC) in 1997; therefore, we are unable to determine the 
timeliness of the SF-FAC submission for 1995 and 1996. See GAO, Single 
Audit: Update on the Implementation of the Single Audit Act Amendments 
of 1996, GAO/AIMD-00-293 (Washington, D.C.: September 2000).

[B] The 2002 Single Audit report was reissued on May 23, 2005. 

[End of table] 

Palau Has Improved Financial Statements' Reliability but Lacks Capacity 
to Address Internal Control Weaknesses:

For 1995-2002, Palau received qualified audit opinions on its 
government's financial statements, indicating that significant issues 
prevented the auditor from concluding that the financial statements 
were reliable overall.[Footnote 44] However, for 2003-2006, Palau's 
financial statements consistently received unqualified audit opinions, 
indicating that the auditor considered the statements reliable. (See 
table 5.)

Table 5: Financial Statement Audit Opinions for Palau, 1995-2006:

Year: 1995; 
Opinion on financial statements: Qualified.

Year: 1996; 
Opinion on financial statements: Qualified.

Year: 1997; 
Opinion on financial statements: Qualified.

Year: 1998; 
Opinion on financial statements: Qualified.

Year: 1999; 
Opinion on financial statements: Qualified.

Year: 2000; 
Opinion on financial statements: Qualified.

Year: 2001; 
Opinion on financial statements: Qualified.

Year: 2002; 
Opinion on financial statements: Qualified.

Year: 2003; 
Opinion on financial statements: Unqualified.

Year: 2004; 
Opinion on financial statements: Unqualified.

Year: 2005; 
Opinion on financial statements: Unqualified.

Year: 2006; 
Opinion on financial statements: Unqualified.

Source: Palau national government's single audit reports for 1995-2006.

Note: All years cited are fiscal years (Oct. 1-Sept. 30). 

[End of table] 

Despite the improved reliability of its financial statements, Palau has 
long-standing and significant weaknesses in its internal control over 
financial reporting.[Footnote 45] Palau's 2006 single audit report 
cited a number of significant weaknesses in basic internal control that 
impact its financial reporting, many of which were cited in previous 
audit reports.[Footnote 46] These weaknesses include, for example, 
nonresolution of differences in monthly bank reconciliations and a lack 
of policies and procedures for reconciling accounts receivable and 
prepayments.

Palau has developed corrective action plans to address these 
weaknesses, such as improving reconciliations to ensure proper entries 
and adjustments. Palau also is updating its financial reporting 
policies and procedures, which, according to officials from Palau's 
Ministry of Finance, date back to 1983. However, according to Palau's 
controller and Palau's current external auditor, Palau has inadequate 
staff and expertise to properly address its financial reporting 
weaknesses and make other necessary improvements in a timely manner. 
For example, Palau relies heavily on one individual to prepare its 
financial statements and has had difficulty in hiring a Chief of 
Finance and Accounting. As a result, Palau is at risk of being unable 
to sustain the improvements it has made in its financial accountability.

Palau Has Weaknesses in Its Compliance with Federal Award Requirements 
and Lacks Capacity to Address These Weaknesses:

Since 1995, Palau's single audits have consistently received qualified 
opinions on its compliance with federal award requirements owing to 
long-standing and significant internal control weaknesses over its 
compliance with such requirements.[Footnote 47] These weaknesses could 
adversely affect Palau's ability to operate a major federal program 
within the applicable requirements of laws, regulations, contracts, and 
grants. For example, in 2006, Palau's auditor cited noncompliance and 
internal control weaknesses in areas such as procurement, cash 
management, and equipment and real property management.[Footnote 48] 
Many of the problems noted in the 2006 report were recurring. For 
instance, the weakness involving lack of effective controls to ensure 
that property is adequately safeguarded from loss, damage, or theft, 
had existed since 1988.[Footnote 49]

Palau has developed corrective action plans to address the 2006 single 
audit findings regarding its compliance with, as well as its internal 
control over compliance with, federal grant requirements. For example, 
according to the 2006 report, Palau plans to strengthen internal 
controls over procurement and address its long-standing weaknesses 
related to adequately accounting for its equipment and real 
property.[Footnote 50] However, Palau's limited staff and expertise 
hinder its ability to address the single audit report's findings in a 
timely manner.

Most Compact-related Reporting Requirements Were Met but Consultation 
Requirements Were Not, and Interior's Oversight Was Limited:

Palau met the majority of the compact's and related agreements' 
reporting requirements. Palau and U.S. officials reported meeting some 
consultation requirements but in most cases did not document their 
compliance. In addition, Interior's OIA and OIG made efforts to assist 
or oversee Palau's accountability for compact funds; however, according 
to agency officials, OIA viewed its oversight role as limited and 
informal.

* Economic development plans. Palau prepared a two-volume economic 
development plan for 1995-1999. It updated this plan with an economic 
study for 2000-2005, which was completed by the Japan International 
Cooperation Agency. According to an official from Palau's Ministry of 
Finance, the next plan is expected to be completed at the end of 2008. 
An Interior official said that several U.S. agencies, including State 
and Interior, provided comments to Palau on its initial economic 
development plan.

* Annual reports. Palau completed the required annual reports and 
submitted them to the U.S. government. According to an Interior 
official, although the agency has reviewed the annual reports, Interior 
has not issued any formal written responses to Palau. As a result, 
there is no documentation regarding whether the U.S. government 
compared the actual use of the compact funds in the preceding year with 
the projected amount or whether the U.S. government agreed or disagreed 
that Palau used compact funds as set forth in its economic development 
plan.

* Annual economic consultations. Officials from the government of 
Palau, as well as OIA and State officials, told us that the U.S. and 
Palau governments held the required economic consultations.[Footnote 
51] However, the officials said that the meetings were informal and 
that they did not produce any written documentation, such as minutes, 
as a result of the meetings. State and OIA officials acknowledged that 
the meetings did not occur on an annual basis and that they usually 
occurred when other meetings between the two countries took place. An 
OIA official told us that the consultations usually lasted about a half-
day. Although the compact does not require the Palau and U.S. 
governments to produce written documentation as a result of the 
consultations, the lack of documentation prevents any assessment of the 
meetings' effectiveness. Furthermore, the lack of documentation makes 
it impossible to ascertain whether these informal consultations 
resulted in any recommendations, which the fiscal procedures agreement 
requires to be produced to the maximum extent possible.

* Trust fund consultations. Officials from the government of Palau and 
from OIA stated that trust fund consultations, required to occur at 5- 
year intervals, did not take place. Because the trust fund 
consultations did not take place, Palau may have lost the opportunity 
to discuss concerns about its trust fund with the United States. For 
example, officials in Palau told us that they interpreted the compact 
and related agreements as prohibiting trust fund managers from 
investing in anything other than U.S. securities. However, the trust 
fund agreement states that the United States government, in 
consultation with the government of Palau, shall consider designating 
other investment-grade instruments as qualified in order that the 
fund's performance objectives are met. If the trust fund consultations 
had taken place, the government of Palau could have raised this issue.

Interior's OIA and OIG reported efforts to assist or oversee Palau's 
accountability for federal funds. According to Interior officials, it 
has monitored Palau's progress in completing and issuing its single 
audit reports; used Palau's single audit and compact annual reports to 
monitor Palau's use of compact funds; worked with Palau to track single 
audit findings and resolve issues; and, considered Palau's requests to 
extend its single audit submission deadlines. In addition, according to 
Interior officials, OIA has provided general technical assistance funds 
to train Palau employees as well as funds to enhance Palau's financial 
management systems and processes. Interior officials also noted that 
Interior's OIG reviewed the single audit reports to determine whether 
they met applicable reporting standards and requirements.

However, an OIA official said that its oversight of compact funding has 
not been extensive, because compact assistance is given to Palau with 
the full faith and credit of the United States and because the compact 
gives Palau broad discretion in compact spending. In a 2006 memorandum, 
Interior's OIG criticized OIA for its minimal oversight and monitoring 
of Palau's compact funding. Although the memorandum did not contain 
recommendations, it suggested that OIA commit additional resources, 
such as a full-time staff member, to oversee accountability for compact 
funds and any other U.S. assistance provided to Palau.

Palau's Prospects for Economic Self-Sufficiency Depend on Multiple 
Factors:

Palau's prospects for long-term economic self-sufficiency depend on at 
least four factors: levels of continued U.S. assistance, the 
availability and value of trust fund withdrawals, fiscal reform to 
reduce Palau's long-term dependence on these withdrawals, and private 
sector growth through an improved business environment. Regarding 
continued U.S. assistance, given the scheduled increase in Palau's 
annual trust fund withdrawals in 2010, the expiration of compact direct 
assistance at the end of 2009 will likely cause a net decline of less 
than 4 percent in the Palau national government's revenues. Potential 
increases or reductions in the future levels of discretionary federal 
programs could have a significant fiscal impact. Moreover, unless the 
federal programs and services agreement is extended beyond 2009, Palau 
will lose postal, weather, and aviation services. Regarding the trust 
fund withdrawals, a compounded annual return of at least 8.1 percent 
will allow Palau to withdraw $15 million per year from its trust fund 
for the planned 35 years; however, market volatility makes it 
increasingly probable that the trust fund will be depleted after 2016, 
and inflation will cause the withdrawals to lose value over time. To 
decrease its reliance on trust fund financing, Palau will require 
fiscal reforms to close the gap between its revenues and expenditures. 
Regarding private sector growth, Palau will need to improve its 
business environment by addressing problems with its foreign investment 
climate; financial system; and land, labor, and commercial policies 
that presently discourage such growth.

Prospects for Economic Self-sufficiency Depend on Levels of Continuing 
U.S. Assistance:

Palau's prospects for economic self-sufficiency depend in part on 
levels of continuing discretionary federal program assistance. We 
estimate that in 2009, the Palau national government's potential 
revenues--compact direct assistance, discretionary federal programs, 
other donor assistance, and domestic revenues[Footnote 52]--will total 
about $87 million (see fig. 5). Domestic revenues, at about $44 million 
in 2009, will have grown from about $30 million in 2000, based on the 
annual growth rate of 4.4 percent from 2000-2006. Other donor 
assistance, at about $18 million in 2009, will have grown from about $6 
million in 2000, based on its annual growth rate of 17.4 percent from 
2000-2006. In addition to potential revenues, Palau's government also 
will have access to financing through earned interest and annual 
withdrawals from the U.S. trust fund and other government assets. (For 
further fiscal information on Palau's national government, see app. 
III.)

Figure 5: Palau National Government's Potential Revenues in 2009:

[See PDF for image] 

This figure is a stacked vertical bar graph depicting the following 
data: 

Palau National Government's Potential Revenues in 2009: 
Domestic revenue: $43.6 million; 
Other donor assistance: $17.8 million; 
Discretionary federal programs: $11.9 million (Discretionary federal 
program annual levels based on eligibility); 
Compact direct assistance: $13.3 million (Compact direct assistance 
expires at the end of 2009); 
Total: $86.6 million. 

Source: GAO analysis. 

Notes:

Years cited are fiscal years (Oct. 1-Sept. 30). All dollar amounts are 
in current (i.e., nominal) dollars.

Domestic revenue includes taxes, fees and charges, licenses and 
permits, and other direct revenues and excludes net investment 
earnings. Total revenues exclude revenues for component units and in- 
kind assistance, such as compact federal services. In addition to 
revenues, Palau will have access to financing, including a $5 million 
annual trust fund withdrawal. Further fiscal information is provided in 
app. III.

To estimate potential 2009 domestic revenue and the level of other 
donor assistance, we reviewed Palau single audit data for 2000-2006 and 
Palau budgets for 2007 and 2008 and applied the average annual growth 
rate from 2000-2008.

Discretionary federal programs exclude the value of DOD's Civic Action 
Team program that is provided in kind. To estimate potential 2009 
discretionary federal program levels, we reviewed Palau budget data for 
2008 and assumed the same level of federal programs would be provided 
in 2009, adjusted for inflation.

The 2009 level of compact direct assistance is based on U.S. agency 
budget data. 

[End of figure] 

Although the expiration of compact direct assistance at the end of 2009 
will reduce the national government's revenues by about $13.3 million, 
Palau will gain access to an additional $10 million in annual financing 
when its yearly trust fund withdrawals increase in 2010 from $5 million 
to $15 million. As a result, the net fiscal impact of expiring compact 
direct assistance will be about $3.3 million annually, or less than 4 
percent of the national government's revenues in 2009. However, levels 
of other forms of U.S. assistance after 2009 will impact Palau's fiscal 
condition:

* Discretionary federal programs. Since most federal programs operating 
in Palau are discretionary, they supply varied levels of annual 
assistance. For example, discretionary federal program assistance to 
the national government grew from $7.3 million in 2000 to $18.8 million 
in 2006, but is expected to fall to $11.3 million in 2008.[Footnote 53] 
Although discretionary federal program funding in 2009 could total 
almost $12 million, or 14 percent of the national government revenues, 
future program funding will depend on Palau's program eligibility 
status and the availability of appropriations. Palau's eligibility for 
some federal programs may expire, absent affirmative action by 
Congress. In addition, the expiration of the compact's federal programs 
and services agreement in 2009 may impact U.S. agencies' implementation 
of discretionary federal programs in Palau. However, U.S. agency 
officials we interviewed expressed uncertainty about the extent of any 
such impact.

* Compact federal services. If compact federal services expire as 
scheduled at the end of 2009, the Palau national government may seek to 
provide these services with its own revenues. For example, unless the 
federal programs and services agreement is renewed or extended, Palau 
will lose postal, weather, and aviation services that are estimated to 
cost U.S. agencies almost $1.6 million in 2009.

Prospects for Economic Self-sufficiency Depend on Availability and 
Value of Trust Fund Withdrawals:

Palau's prospects for economic self-sufficiency also depend in part on 
the availability of the planned $15 million annual trust fund 
withdrawals and the value of those withdrawals over time. Palau will be 
able to withdraw $15 million per year from its trust fund for the 
planned 35 years--from 2010 through 2044--if the fund earns a 
compounded annual return of at least 8.1 percent.[Footnote 54] To grow 
in perpetuity, the trust fund must earn a compounded return rate of 8.6 
percent or higher. Both of these rates are lower than the 9 percent 
return that the trust fund has earned from its inception in 1995 
through March 2008; however, forecasts of future returns are subject to 
considerable uncertainty. The historical rate of return for the asset 
classes held in the fund's portfolio differ depending on the time 
period considered. For example, the compounded rate of return was 8.1 
percent for 1926-2007, 9.1 percent for 1970-2007, and 5.2 percent for 
1998-2007.[Footnote 55] If the trust fund continues to earn the 9 
percent annual return it has earned thus far, or any rate equal to or 
greater than 8.6 percent, the trust fund will likely grow in perpetuity 
from its balance as of March 2008 (see fig. 6).

Figure 6: Palau's Trust Fund Account Balance with Three Rates of Return 
(Dollars in millions):

[See PDF for image] 

The Palau trust fund had a balance of $160.775 million as of March 
2008. 

This figure is a multiple line graph depicting the following data: 

Fiscal year: 2008; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $173.2; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $172.4
Palau Trust Fund Balance, $8.1% (rate of return needed to sustain the 
trust fund for 35 years): $171.5. 

Fiscal year: 2009; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $183.7; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $180.1. 

Fiscal year: 2010; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $184.7; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $179.1. 

Fiscal year: 2011; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $185.9; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $177.9. 

Fiscal year: 2012; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $187.1; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $176.7. 

Fiscal year: 2013; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $188.5; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $175.4. 

Fiscal year: 2014; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $189.9; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $173.9. 

Fiscal year: 2015; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $191.6; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $172.4. 

Fiscal year: 2016; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $193.3; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $170.8. 

Fiscal year: 2017; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $195.2; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $170.0. 

Fiscal year: 2018; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $197.3; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $167.1. 

Fiscal year: 2019; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $199.6; 	
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $164.9. 

Fiscal year: 2020; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $202.1; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $162.7. 

Fiscal year: 2021; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $204.8; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $160.3. 

Fiscal year: 2022; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $207.7; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $157.6. 

Fiscal year: 2023; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $210.9; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $154.8. 

Fiscal year: 2024; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $214.4; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $151.7. 

Fiscal year: 2025; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $218.3; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $148.4. 

Fiscal year: 2026; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $222.4; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $144.8. 

Fiscal year: 2027; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $226.9; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $140.9. 

Fiscal year: 2028; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $231.9; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $136.8. 

Fiscal year: 2029; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $237.3; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $132.2. 

Fiscal year: 2030; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $243.2; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $127.4. 

Fiscal year: 2031; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $249.6; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $122.1. 

Fiscal year: 2032; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $256.6; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $116.4. 

Fiscal year: 2033; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $264.2; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $110.3. 

Fiscal year: 2034; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $272.5; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $103.7. 

Fiscal year: 2035; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $281.6; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $96.5. 

Fiscal year: 2036; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $291.4; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $88.8. 

Fiscal year: 2037; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $302.2; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $80.4. 

Fiscal year: 2038; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $313.9; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $71.4. 

Fiscal year: 2039; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $326.7; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $61.8. 

Fiscal year: 2040; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $340.6; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $51.2. 

Fiscal year: 2041; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $355.8; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $39.8. 

Fiscal year: 2042; 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $372.3; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $27.5. 

Fiscal year: 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $390.4; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $14.3. 

Fiscal year: 
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust 
fund earned from inception to March 2008): $410.0; 
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust 
fund in perpetuity): $181.9; 
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the 
trust fund for 35 years): $0.000421. 

Source: GAO analysis. 

Note: Years shown are fiscal years (Oct. 1-Sept. 30). All return rates 
are net of fees and commissions. 

[End of figure] 

However, market volatility adds uncertainty regarding the availability 
of the trust fund withdrawals. Despite its historical compounded annual 
return rate of 9 percent as of March 2008, the trust fund's annual 
investment returns have ranged from 24 percent in 1998 to negative 12 
percent in 2002. Future returns to the Palau trust fund portfolio are 
uncertain. Even if the trust fund earns a favorable long-run return 
which could allow the fund to grow in perpetuity without market 
volatility,[Footnote 56] a few consecutive years of poor stock market 
performance could lead to the depletion of the trust fund. Figure 7 
illustrates results from our analysis with the assumption that future 
returns are drawn from distributions based on historical 1970-2007 
returns of the asset classes in which Palau's trust fund is invested. 
Our analysis shows that the trust fund will be able to disburse $15 
million per year through 2016 but is increasingly likely to be depleted 
after 2016. For example, by 2030, 20 years after the annual $15 million 
disbursement begins, the probability of the trust fund depletion is 
close to 26 percent; by 2044, 35 years after the $15 million 
disbursement begins, the probability reaches approximately 46 percent. 
Figure 7 illustrates results from our analysis based on the historical 
returns for 1970-2007 of the asset classes held in the Palau trust 
fund. (For a detailed discussion of our methodology and results, see 
app. IV.)

Figure 7: Probability That Palau Trust Fund Will Be Depleted Given 
Market Volatility, 2010-2044:

[See PDF for image] 

This figure is a line graph depicting the following data: 

Fiscal year: 2010; 
Percentage: 0. 

Fiscal year: 2011; 
Percentage: 0. 

Fiscal year: 2012; 
Percentage: 0. 

Fiscal year: 2014; 
Percentage: 0. 

Fiscal year: 2015; 
Percentage: 0. 

Fiscal year: 2016; 
Percentage: 0. 

Fiscal year: 2017; 
Percentage: 0.03%. 

Fiscal year: 2018; 
Percentage: 0.16%. 

Fiscal year: 2019; 
Percentage: 0.52%

Fiscal year: 2020; 
Percentage: 1.37%. 

Fiscal year: 2021; 
Percentage: 2.91%. 

Fiscal year: 2022; 
Percentage: 4.94%. 

Fiscal year: 2023; 
Percentage: 7.12%. 

Fiscal year: 2024; 
Percentage: 9.73. 

Fiscal year: 2025; 
Percentage: 12.37%. 

Fiscal year: 2026; 
Percentage: 15.34%. 

Fiscal year: 2027; 
Percentage: 18.13%. 

Fiscal year: 2028; 
Percentage: 20.74%. 

Fiscal year: 2029; 
Percentage: 23.66%. 

Fiscal year: 2030; 
Percentage: 25.97%. 

Fiscal year: 2031; 
Percentage: 28.38%. 

Fiscal year: 2032; 
Percentage: 30.58%. 

Fiscal year: 2033; 
Percentage: 32.45%. 

Fiscal year: 2034; 
Percentage: 34.08%. 

Fiscal year: 2035; 
Percentage: 35.86%. 

Fiscal year: 2036; 
Percentage: 37.54%. 

Fiscal year: 2037; 
Percentage: 38.85%. 

Fiscal year: 2038; 
Percentage: 39.96%. 

Fiscal year: 2039; 
Percentage: 41.19%. 

Fiscal year: 2040; 
Percentage: 42.33%. 

Fiscal year: 2041; 
Percentage: 43.3%. 

Fiscal year: 2042; 
Percentage: 44.26%. 
	
Fiscal year: 2043; 
Percentage: 45.18%. 

Fiscal year: 2044; 
Percentage: 46%. 

Source: GAO analysis. 

Notes:

All years cited are fiscal years (Oct. 1-Sept. 30).

This chart depicts results from 10,000 trial runs. For each run, the 
returns of each of the asset classes are randomly drawn from a 
distribution based on the historical returns (1970-2007). The account 
balances and the amount of disbursements from the trust fund are then 
calculated based on the returns. The probability of not being able to 
disburse $15 million is then generated from a distribution of 10,000 
disbursements each year. 

[End of figure] 

In addition, inflation will diminish the value of the annual trust fund 
withdrawals: because the withdrawals are not adjusted for inflation, 
[Footnote 57] they will lose real value over time. We estimate that by 
2044-the last year of planned trust fund assistance-the value of the 
annual withdrawal will have decreased by about half compared with its 
value in 2010.[Footnote 58]

Prospects for Economic Self-Sufficiency Depend on Fiscal Reform:

Palau's prospects for economic self-sufficiency depend in part on 
fiscal reform to reduce Palau's long-term dependence on trust fund 
withdrawals. Government officials and IMF experts have defined fiscal 
sustainability for Palau after 2009 as having sufficient domestic 
revenues, such as tax and fee income, to pay for operating 
expenditures, such as those for wages, goods, and services.[Footnote 
59] Continued donor assistance could be used to pay for capital 
expenditures. In 2000-2006, domestic revenues provided an average of 50 
percent of national government revenue, while operating expenditures 
accounted for an average of 79 percent of national government spending. 
Beginning in 2010, Palau will have access to the $15 million annual 
trust fund withdrawals to finance the gap between its revenues and 
expenditures. However, Palau's long-term fiscal sustainability relies 
on reduced dependence on the full trust fund withdrawal, given (a) the 
uncertainty of continued donor assistance for capital spending, (b) the 
declining real value of the annual withdrawal, and (c) the planned 
exhaustion of the trust fund in 2044, with risks for its earlier 
exhaustion due to market volatility.[Footnote 60] According to economic 
experts, Palau officials, and the country's economic plans, 
implementation of tax and expenditure reforms will be needed to close 
the gap between Palau's revenues and expenditures, although full 
implementation of such reforms is expected to require 10 to 15 years. 
[Footnote 61]

Tax revenues. In 2006, tax revenue provided about $30 million and was 
equivalent to 19 percent of GDP, a level broadly comparable to that of 
other Pacific island nations. However, IMF and Asian Development Bank 
(ADB) experts describe Palau's tax system as inefficient because of, 
among other problems, weak tax administration and ineffective tax 
policy:

* Tax administration. Tax compliance in Palau is low, and the 
government rarely collects assessed penalties and interest or exercises 
its authority to suspend or revoke business licenses. The IMF and ADB 
estimate that fewer than 50 percent of active taxpayers are fully 
compliant. For example, in a 2004-2005 review, the Palau Office of the 
Public Auditor found that Palau lost more than $7.5 million in 
uncollected taxes and penalties for just 15 businesses in 1998-2005. 
[Footnote 62] Also, although the government conducts tax audits, it 
rarely closes noncompliant businesses and usually waives penalties and 
interest. For example, in 2007, the government settled with Palau 
Marine Industries Corporation to pay $1.25 million on a court-awarded 
total obligation of over $5.7 million for unpaid taxes from 1999 
through 2004.[Footnote 63] The IMF and ADB are working with Palau on a 
tax modernization project to improve Palau's tax administration and 
possibly establish a Large Taxpayer Unit to focus on Palau's largest 
taxpayers.

* Tax policy. Experts and officials stated that Palau's tax policy 
allows numerous and complicated exemptions, and the current system does 
not tax nonwage income, such as that from profits, investment, or 
property. Additionally, Palau taxes businesses on gross, rather than 
net, earnings. To address these problems, Palau has consulted with the 
IMF and ADB since the 1990s and began devising tax reform legislation 
in 1998. However, Palau authorities indicated an intention to focus 
initially on short-term measures, primarily addressing rates and 
exemptions, and pursue structural reform over the long term. Palau's 
2007 Tax Reform Task Force suggested 19 short-term measures that it 
estimated could provide an additional $31 million in revenues. To date, 
2 of the 19 measures--increasing the hotel room tax rate and fish 
export tax rate--have been implemented.

Expenditures. Economic experts and government officials also suggest 
that Palau could lower its operating expenditures, at around $67 
million in 2006, by reducing the public sector wage bill:

* Public sector wage bill. Although Palau has slightly reduced nonwage 
operating expenditures since 2000, it has been less successful in 
reducing the wage bill. From 2000-2006, Palau's national government 
wage bill grew from 46 percent to 50 percent of its operating 
expenditures, with wage levels nearly twice those in the private 
sector. According to government officials, Palau instituted a freeze on 
public sector employment in 2001 that has not been observed, and recent 
public sector reclassification efforts will result in a further 
increase in wage expenditures.[Footnote 64]

Palau's Prospects for Economic Self-sufficiency Depend on Improved 
Business Environment for Private Sector Growth:

Palau's prospects for economic self-sufficiency depend in part on the 
growth of its economy through private sector expansion, which will 
require an improved business environment. Palau's strategy for 
expanding its private sector focuses primarily on pursuing 
environmentally sustainable growth by promoting high-end tourism and 
capitalizing on growth opportunities from the new compact road. 
[Footnote 65] Officials, experts, and private sector representatives 
view the tourism sector as offering the most potential for growth. For 
example, the IMF estimates that every 2 percent increase in tourist 
arrivals creates a 1 percent increase in tourism-related employment and 
that more than a third of foreign direct investment occurs in this 
sector. Current Palau tourism strategies aim to capitalize on 
opportunities for high-end tourists[Footnote 66] from Asia and from 
U.S. military bases on Guam. The marine and agricultural industries 
together provide less than 5 percent of GDP; however, Palau is pursuing 
opportunities in aquaculture and considering whether foreign fishing 
license fees could be raised. In all cases, private sector development 
is dependent on sustained exploitation of Palau's fragile environmental 
resources.[Footnote 67]

However, according to Palau government officials, economic experts, and 
private sector representatives, problems related to Palau's foreign 
investment policies, financial systems, land ownership system, labor 
market, and commercial conditions create a costly business environment 
that discourages private sector growth:

* Foreign investment policies. Palau imposes stringent requirements on 
foreign investment, restricting foreign investment in certain 
activities and requiring all applications to be approved by its Foreign 
Investment Board. According to officials from the board and Palau's 
foreign investment regulations, foreign investment in allowed 
activities must meet a minimum of $500,000 or have a minimum 20 percent 
Palauan ownership. Private sector representatives indicated that the 
Foreign Investment Board has significant discretion and applies the law 
inconsistently. Both officials and private sector representatives 
reported that burdensome requirements have encouraged the establishment 
of front businesses, where foreign investors operate illegally through 
a Palauan partner.

* Financial systems. Palau's financial markets do not effectively 
finance investment but instead supply large amounts of consumer credit. 
Moreover, Palau's foreign banks are unable to accept land as 
collateral, and financial regulations remain weak.[Footnote 68] 
According to the IMF, Palau's Financial Institutions Act allows for 
insufficient bank liquidity and does not sufficiently empower the 
government to supervise bank compliance. The recent failure of Pacific 
Savings Bank illustrates the impact of weak regulation.[Footnote 69] In 
commenting on this report, officials from Palau's Financial 
Institutions Commission said that recent legislative amendments will 
allow the Commission to strengthen its supervision of Palau's banking 
industry.

* Land ownership system. Palau's system of land ownership prevents the 
effective use of land for development. Much of Palau's land is family 
owned and not officially registered. Palau's Land Court is working to 
ensure that all lands are registered. However, Bureau of Lands and 
Surveys officials were unable to locate reliable statistics on 
registrations and suggested that fewer than 3,000 of 17,000 existing 
parcels had been referred to the Court. Separately, Land Court 
officials suggested that about 4,100 parcels had been registered.

* Labor market. Private sector representatives indicated a lack of 
available skilled labor in Palau, and Palau government officials 
expressed concern about illegal importation of unskilled foreign 
workers. ADB reports emphasize that current labor laws discriminate 
against the import of skilled labor and that minimum wage laws for 
Palauan workers encourage importation of unskilled foreign labor 
through unlicensed recruiters. Palau's Department of Labor receives 
many grievances from the Philippines Embassy about treatment of 
unskilled workers, who are often paid less than $150 per month and lack 
health benefits.

* Commercial conditions. Experts describe Palau's commercial legal 
system as outdated and lacking laws for bankruptcy, sales, and consumer 
privacy protection. Additionally, private sector representatives 
complained that the government often delays payment of vendors for 
several years.[Footnote 70] Officials and private sector 
representatives also emphasized that, owing to the small size of the 
population, government officials often engage in private sector 
activities that create commercial conflicts of interest. For example, 
according to these officials and representatives, government officials 
with interests in construction companies or banking often are unwilling 
to enforce environmental or financial regulations.

Conclusions:

In 2009, the governments of the United States and Palau will formally 
review the terms of the compact and its related agreements. Compact and 
other U.S. assistance has contributed to several areas important to 
Palau's self-sufficiency and economic advancement. For example, Palau 
used U.S. assistance to support governmental operations, maintain 
needed services, develop infrastructure, and improve public health and 
education. Although compact direct assistance will expire in 2009, the 
provision of federal services--postal, weather, and aviation--may 
continue if the federal programs and services agreement is renewed or 
extended. Moreover, it is likely that some discretionary federal 
programs will continue, although the level of federal program funding 
depends on Palau's continued eligibility, which may require affirmative 
action by Congress in some cases. Interior's OIA will continue to be 
the cognizant agency for Palau for the remaining compact direct 
assistance and to review Palau's single audits as long as U.S. federal 
program funds are expended in Palau. Palau has made progress in 
financial accountability, improving the timeliness of single audit 
report submissions and the reliability of its financial statements. 
However, Palau's single audit reports show persistent weaknesses in 
Palau's internal controls over financial reporting and compliance with 
federal award requirements. At the same time, Palau has limited 
capacity to address these weaknesses in a timely manner. Unless Palau 
strengthens its financial accounting resources and expertise, its 
ability to sustain its recent progress in financial accountability and 
to operate a major federal program according to applicable requirements 
is at risk.

Recommendation for Executive Action:

To strengthen Palau's ability to provide accountability and meet 
applicable requirements for federal assistance, we recommend that the 
Secretary of the Interior direct the Office of Insular Affairs to (1) 
formally consult with the government of Palau regarding Palau's 
financial management challenges and (2) target future technical 
assistance toward building Palau's financial management capacity.

Agency Comments and Our Evaluation:

We provided a draft of this report to the Secretary of the Interior, 
the Secretary of State, and the government of Palau. The Secretary of 
the Interior and the government of Palau provided comments, which we 
have included in appendixes VIII and IX, respectively. The Department 
of State did not comment on the report. In addition, we received 
technical comments from USDA, Education, and Homeland Security, as well 
as the FAA, NWS, USPS, and the USACE, which we have incorporated as 
appropriate.

The Department of the Interior agreed with our report's findings and 
said that the report was useful to the department as it prepared for 
the compact review between the United States and Palau. Interior 
concurred with our recommendation, noting that it had begun preliminary 
discussions with its training partner, the U.S. Department of 
Agriculture Graduate School, to implement a program of leadership and 
succession planning for key positions in the island governments, and 
that it would address Palau's needs specifically as part of the compact 
review. The government of Palau also agreed with our findings and noted 
that Interior's OIA had provided support to Palau's on-going efforts to 
improve its financial management capacity through the Pacific Islands 
Training Initiative and the Financial Management Improvement Program. 
In addition, the government of Palau supported our recommendation that 
OIA continue to assist Palau in building financial management capacity. 
Palau added that it intended to establish an ongoing institutional 
strengthening program focused on human resource development and 
improved retention of key personnel to ensure the sustainability of its 
financial management improvements.

We are sending this report to the Secretary of the Interior, the 
Secretary of State, the government of Palau, and interested 
congressional committees. In addition, the report will be available at 
no charge on GAO's Web site, at [hyperlink, http://www.gao.gov].

If you or your staffs have questions regarding this report, please 
contact me at (202) 512-3149 or [email protected]. Contact points for 
our Offices of Congressional Relations and Public Affairs may be found 
on the last page of this report. GAO staff who made major contributions 
to this report are listed in appendix X. 

Signed by: 

David Gootnick: 
Director, International Affairs and Trade:

[End of section]

Appendix I: Objectives, Scope, and Methodology:

This report examines (1) the provision of compact and other U.S. 
assistance to Palau from 1995-2009,[Footnote 71] (2) Palau's and U.S. 
agencies' efforts to provide accountability over Palau's use of federal 
funds in 1995-2006, and (3) Palau's prospects for achieving economic 
self-sufficiency.

To address our objectives, we reviewed the Compact of Free Association 
between Palau and the United States and subsidiary agreements related 
to the compact, Palau's compact annual reports for 1995-2006, Palau's 
single audit reports for 1995-2006,[Footnote 72] Palau government 
budgets, economic studies, and documentation for the compact road 
project. We interviewed agency officials at the Department of the 
Interior's (Interior) Office of Insular Affairs (OIA) and Office of the 
Inspector General (OIG), and the Departments of State (State), 
Agriculture (USDA), Defense (DOD), Education (Education), Health and 
Human Services (HHS), Homeland Security, Labor, and Transportation 
(DOT). We also interviewed officials from the U.S. Army Corps of 
Engineers (USACE), the Federal Aviation Administration (FAA), the U.S. 
Postal Service (USPS), and the National Weather Service (NWS), as well 
as economic experts from the International Monetary Fund (IMF) and the 
Asian Development Bank (ADB). We traveled to Palau where we conducted 
site visits and interviewed government officials from a range of 
ministries, including the ministries of Finance, Health, Education, and 
Resources and Development, and the Office of the Public Auditor. We 
also interviewed Palau's external auditor and met with representatives 
of the private sector and nongovernmental organizations in Palau. We 
inspected the compact road and viewed infrastructure improvements made 
to Palau's airport that were funded by FAA's Airport Improvement 
Program.

To identify compact and other types of U.S. assistance to Palau in 1995-
2009, we reviewed the compact and its related agreements; Palau's 
compact annual reports; Palau government budgets; and single audit 
reports for the Palau national government, the Palau Community College, 
and the Palau Community Action Agency. We used OIA budget 
justifications to estimate compact direct assistance from 1995 to 2009, 
as well as the estimated U.S. cost for the compact road. We used 
information provided by agency officials at FAA, USPS, and NWS to 
estimate the cost of compact federal services. Because FAA's cost 
estimates included the costs of providing services to six airports in 
Micronesia, we divided this cost by six to calculate a general estimate 
of the costs associated with Palau's one airport. USPS provided us with 
cost estimates from 1995 through 2009. NWS provided us with cost 
estimates from 2004 through 2007; we averaged these 4 years of data to 
estimate the annual costs in 1995-2003 and 2008-2009. We used single 
audit information from the three primary grant recipients--the Palau 
national government, the Palau Community College, and the Palau 
Community Action Agency--to determine those entities' actual grant 
expenditures. We estimated the Palau national government's grant 
expenditures for 2007-2009 using its budgetary estimates for those 
years and we projected grant expenditures for the other two entities 
based on their 2006 actual expenditures, after adjusting for inflation. 
We used information provided by DOD officials to estimate the cost to 
the department of providing the Civic Action Team (CAT) to Palau in 
1995-2009. To include personnel as well as operating expenses, we 
adjusted the CAT's 2007 personnel cost for inflation to provide a broad 
estimate for 1995-2009.

To assess Palau's and U.S. agencies' efforts to provide accountability 
over Palau's use of federal funds in 1995-2006, we reviewed the compact 
and its related agreements to identify specific monitoring and 
accountability responsibilities and assessed the extent to which the 
Palau and U.S. governments conducted those responsibilities. We met 
with State and OIA officials to learn about their monitoring and 
oversight activities. We interviewed Palau government officials to 
identify Palau's accountability measures over federal grant awards. We 
also interviewed Palau's external auditor to discuss Palau's single 
audit results, accountability mechanisms, and accountability 
challenges. We reviewed the Palau national government single audit 
reports for 1995-2006 as well as audit reports from Palau's Office of 
the Public Auditor. We determined the timeliness of submission of the 
single audit reports using the Federal Audit Clearinghouse's (FAC) 
"Form Date," which is the most recent date that the required SF-FAC 
data collection form was received by the FAC.[Footnote 73] We noted 
that the form date is updated if revised SF-FACs for that same fiscal 
year are subsequently filed. Our review of the contents of the single 
audit reports' contents identified the auditors' opinions on the 
financial statements and on Palau's compliance with federal grant 
requirements, matters cited by the auditors in their qualified 
opinions, the numbers of material weaknesses and reportable conditions 
reported by the auditors, and the status of corrective actions. We did 
not independently assess the quality of the audits or the reliability 
of the audit-finding information. We analyzed the audit findings to 
determine whether they had recurred in successive single audits and 
were still occurring in the most recent audits, and we categorized the 
auditors' opinions on the financial statements and Palau's compliance 
with major federal programs. To determine oversight activities, we 
reviewed Interior's OIG memorandums issued in December 2005 and January 
2006 on Palau, as well as the OIG's desk review of Palau's single audit 
reports for 2002-2006.

To analyze Palau's prospects for achieving economic self-sufficiency, 
we used the data we had developed concerning compact and other U.S. 
assistance to Palau, as well as Palau's national government budgetary 
information, to describe the role of U.S. financial assistance to the 
government of Palau. We reviewed Palau's compact annual reports, 
economic development plans, and data for sector employment and 
production levels. We also reviewed studies and interviewed officials 
from the U.S. and Palau governments, Palau's private sector, the IMF, 
and the ADB. As part of this analysis, we projected Palau's trust fund 
balance and likely disbursement. To do so, we built a simulation model 
with the following inputs: (1) the trust fund's balance at the 
beginning of the projection, (2) disbursement and inflation adjustment, 
(3) the trust fund balance projection equation, and (4) distribution of 
returns for the Monte Carlo simulation. The trust fund balance as of 
March 2008 is the beginning balance for the projection. We followed the 
disbursement schedule outlined in the compact and the trust fund 
agreement. We ran the Monte Carlo simulation to analyze the effect of 
market volatility on the trust fund balance and disbursement. We base 
our projection on historical returns and volatility; however, the 
actual return on the trust fund may be different.

To determine the challenges encountered in the planning, design, and 
construction of the compact road, and the challenges that remain for 
the maintenance of the compact road, we interviewed officials from OIA, 
State, USACE, and the Palau government; nongovernmental individuals, 
including the author of the maintenance plan for the compact road; and 
the representative of a contracting firm in Palau. In Palau, we 
inspected the entire compact road to identify any obvious problems with 
the road. We also visited other roads maintained by Palau and reviewed 
the equipment Palau uses to maintain roads. In addition, we reviewed 
reports, equipment inventories, contract documents, budgets, plans, 
manuals, guidance, Internet Web sites, court decisions, and laws 
relevant to the construction and maintenance of the compact road. We 
did not interview Daewoo Engineering and Construction Co., Ltd., the 
contractor for the compact road, due to ongoing litigation between the 
contractor and the United States. (See app. V for more information 
about the compact road.)

We conducted this performance audit from October 2007 to June 2008 in 
accordance with generally accepted government auditing standards. Those 
standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe that 
the evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives.

[End of section]

Appendix II: Relevancy of Amendments Made to FSM and RMI Compacts for 
Palau Compact Review:

In 1986, the United States entered into a Compact of Free Association 
with the Federated States of Micronesia (FSM) and the Republic of the 
Marshall Islands (RMI).[Footnote 74] The three countries renegotiated 
the compact in 2003 to provide an additional 20 years of economic 
assistance and to address defense and immigration issues.[Footnote 75] 
The aims of the amended FSM and RMI compacts were to (1) continue 
economic assistance to the FSM and RMI while improving accountability 
and effectiveness; (2) continue the defense relationship between the 
United States and the FSM and the RMI including a 50-year lease 
extension of U.S. military access to Kwajalein Atoll in the RMI until 
2066, with an option to extend for an additional 20 years to 2086; and 
(3) strengthen immigration provisions.[Footnote 76] Some of these 
amendments may be relevant for the Palau compact review in 2009, but 
others may be less relevant due to the differences between Palau's 
compact and the FSM's and the RMI's compacts and Palau's performance 
under its compact.

FSM's and RMI's Renegotiated Compacts Continued Economic Assistance 
while Increasing Accountability Requirements:

The FSM's and the RMI's amended compacts authorized additional economic 
assistance while increasing the accountability requirements for the two 
countries and the United States. The new authorized funding took the 
form of 20 years of annual grants, contributions to a newly established 
trust fund for each country, and an extension of federal services. 
[Footnote 77] The amended compacts established additional 
accountability measures over the annual grant funds. For example, new 
authorized funding was targeted to priority areas such as health, 
education, the environment, and public infrastructure. Joint economic 
management committees were established for each country to more closely 
monitor and evaluate the FSM's and the RMI's progress, and annual 
reporting requirements were expanded. The United States and the FSM and 
the RMI jointly manage the two countries' trust funds. The amended 
compacts grant the United States the authority to withhold payments if 
either the FSM or the RMI fail to comply with grant terms and 
conditions or if they do not cooperate in U.S. investigations regarding 
use of compact funds.

Based on our interviews with U.S. government officials concerning 
Palau's compact review, it is unclear whether a new economic assistance 
package will be offered to Palau and, if it were offered, whether 
additional accountability measures would be sought. Moreover, the 
establishment of a trust fund for the FSM and the RMI is not relevant 
for Palau since Palau's initial compact included a trust fund. One 
issue that is relevant for Palau is the continuation of compact federal 
services--postal, weather, and aviation--which the United States 
provides to Palau. In our discussions with officials from USPS, NWS, 
and FAA, we were told that each agency would like to continue offering 
these services to Palau, although they may seek some minor changes to 
the services provided.

Defense Issues in the Amended FSM and RMI Compacts:

The most significant defense-related change in the amended FSM and RMI 
compacts was the extension of U.S. military access to Kwajalein Atoll 
in the RMI. A few other expiring defense provisions were extended 
indefinitely in the amended compacts, such as the U.S. "defense veto" 
and the ability of FSM and RMI citizens to volunteer to serve in the 
U.S. military. In the amended FSM and RMI compacts, CATs were 
eliminated; instead, both countries were given access to humanitarian 
assistance programs that would emphasize health, education, and 
infrastructure projects that DOD would carry out. DOD officials told us 
that defense provisions in title three of the Palau compact do not 
expire until 2044. The provision of the CATs to Palau, which is 
provided for in the Palau compact's implementing legislation, continues 
indefinitely, although DOD officials told us the CAT program in Palau 
will continue until 2044.

Strengthened Immigration Provisions in the Amended FSM and RMI Compacts:

Although the immigration provisions in the original FSM and RMI compact 
were not expiring, State targeted them as requiring change during the 
compact renegotiation process. The major change in the amended compacts 
is that FSM and RMI citizens were required to present a passport before 
being allowed to enter the United States, which the original compact 
did not require. Other changes to the immigration provisions tightened 
rules for the entry of naturalized citizens from the FSM and the RMI, 
amended provisions for adopted children, and amended conditions on 
admission for compact nonimmigrants.

State officials said that it would be desirable for immigration 
provisions of Palau's compact to be in line with the FSM and RMI 
compacts. This is one issue the U.S. government will look at in 
preparation for the 2009 compact review. Department of Homeland 
Security officials said that they would like citizens of Palau to be 
required to present passports for admission into the United States to 
aid officers in their inspection of Palauans' identity documents. Data 
requested from Homeland Security showed that some citizens of Palau 
enter the United States using identity documents other than a passport. 
However, the port director at the airport in Guam, the port of entry 
through which many Palauans enter the United States, did not cite 
specific concerns over this lack of a passport requirement. He said 
that the Palauans' ability to enter without a passport may cause some 
confusion at other ports where officers may be less familiar with 
Palauan citizens' immigration privileges. In commenting on this report, 
officials from U.S. Customs and Border Protection stated that a 
passport requirement for citizens of Palau entering the United States 
would eliminate confusion at ports that typically do not see these 
individuals, and that it would be in alignment with the Western 
Hemisphere Travel Initiative requirements already in place. In 
addition, they stated that having a passport would facilitate Palauan 
citizens in obtaining a Social Security card, driver's license, or 
other government-issued identification cards that generally require a 
passport as a supporting document.

Supplemental Education Grant in the Amended FSM and RMI Compacts' 
Implementing Legislation:

In addition to receiving compact grants, the FSM and the RMI are 
eligible for a Supplemental Education Grant. The amended compacts' 
implementing legislation authorized appropriations to the U.S. 
Secretary of Education on an annual basis beginning in 2005, to 
supplement the education grants under the amended compacts. The 
supplement grant is awarded in place of grant assistance formerly 
awarded to the countries under several U.S. education, health, and 
labor programs.

[End of section]

Appendix III: Economic Information for Palau:

This appendix provides fiscal and economic information for Palau's 
national government. Specifically, table 6 provides data on Palau's 
actual revenue and expenditures for 2000 to 2006 and estimated values 
for these items in 2009. In addition to its annual revenues, Palau has 
access to financing through net changes in its government assets. One 
key source of financing for Palau is interest earned on the compact- 
provided trust fund, as well as the permitted annual withdrawals from 
the fund. Given that this trust fund was designed to provide Palau with 
financing only until 2044, in addition to the market volatility 
associated with investment earnings, we have excluded net financing 
from the revenues illustrated in table 6. Instead, both net 
investments--defined as the net increase in the fair value of 
investments minus investment management fees--and annual trust fund 
withdrawals are provided as memo items in the table. For further 
information on 2006 fiscal and economic data for Palau, in comparison 
to the RMI and the FSM, see table 7.

Table 6: Palau's National Government Finances, 2000-2006 (Dollars in 
thousands):

Total revenue: 
2000: $57,263; 
2001: $58,925; 
2002: $59,432; 
2003: $65,551; 
2004: $68,720; 
2005: $73,717; 
2006: $83,324; 
Potential 2009[B]: $86,606.

Domestic revenue[A]: 
2000: $29,993; 
2001: $30,943; 
2002: $30,648; 
2003: $31,343; 
2004: $32,667; 
2005: $38,928; 
2006: $38,975; 
Potential 2009[B]: $43,632.

Domestic revenue[A], Tax income: 
2000: $24,398; 
2001: $25,648; 
2002: $24,097; 
2003: $24,723; 
2004: $26,130; 
2005: $30,085; 
2006: $29,376; 
Potential 2009[B]: $35,599.

U.S. assistance: 
2000: $20,908; 
2001: $21,091; 
2002: $21,481; 
2003: $21,962; 
2004: $26,320; 
2005: $21,225; 
2006: $31,525; 
Potential 2009[B]: $25,185.

U.S. assistance, Compact direct assistance: 
2000: $13,642; 
2001: $13,785; 
2002: $13,928; 
2003: $13,928; 
2004: $14,071; 
2005: $10,471; 
2006: $12,717; 
Potential 2009[B]: $13,271.

U.S. assistance, Discretionary federal programs[C]: 
2000: $7,266; 
2001: $7,306; 
2002: $7,553; 
2003: $8,034; 
2004: $12,249; 
2005: $10,754; 
2006: $18,808; 
Potential 2009[B]: $11,914.

Other donor assistance: 
2000: $6,362; 
2001: $6,891; 
2002: $7,303; 
2003: $12,246; 
2004: $9,733; 
2005: $13,564; 
2006: $12,824; 
Potential 2009[B]: $17,789.

Total expenditure: 
2000: $77,609; 
2001: $77,432; 
2002: $80,867; 
2003: $76,840; 
2004: $83,057; 
2005: $78,086; 
2006: $89,342; 
Potential 2009[B]: $92,655.

Operating expenditure[D]: 
2000: $65,108; 
2001: $62,071; 
2002: $59,829; 
2003: $61,495; 
2004: $63,030; 
2005: $64,450; 
2006: $66,614; 
Potential 2009[B]:$67,616.

Operating expenditure[D], Wages and salaries: 
2000: $29,990; 
2001: $30,573; 
2002: $31,405; 
2003: $32,759; 
2004: $31,910; 
2005: $32,309; 
2006: $33,242; 
Potential 2009[B]: $34,580.

Capital expenditures: 
2000: $12,501; 
2001: $15,361; 
2002: $21,038; 
2003: $15,345; 
2004: $20,027; 
2005: $13,636; 
2006: $22,728; 
Potential 2009[B]: $25,039.

Memo items, Net investments[E]: 
2000: $16,863; 
2001: -$14,405; 
2002: -$3,439; 
2003: $18,191; 
2004: $10,748; 
2005: $18,273; 
2006: $9,866; 
Potential 2009[B]: [Empty]. 

Memo items, U.S. trust fund withdrawal: 
2000: $0; 
2001: $0; 
2002: $5,000; 
2003: $5,000; 
2004: $5,000; 
2005: $5,000; 
2006: $5,000; 
Potential 2009[B]: $5,000.

Memo items, Gross domestic product (GDP); 
2000: $118,269; 
2001: $123,458; 
2002: $120,755; 
2003: $121,909; 
2004: $130,852; 
2005: $141,889; 
2006: $154,430; 
Potential 2009[B]: [Empty].

Memo items, U.S. cost of compact federal services received[F]: 
2000: $1,742; 
2001: $1,742; 
2002: $1,745; 
2003: $1,749; 
2004: $1,584; 
2005: $1,623; 
2006: $1,678; 
Potential 2009[B]: $1,595.

Memo items, Population (actual number); 
2000: 18,766; 
2001: 19,092; 
2002: 19,409; 
2003: 19,717; 
2004: 20,016; 
2005: 20,303; 
2006: 20,579; 
Potential 2009[B]: [Empty].

Percentage of GDP (%), Total revenues: 
2000: 48%; 
2001: 48%; 
2002: 49%; 
2003: 54%; 
2004: 53%; 
2005: 52%; 
2006: 54%; 
Potential 2009[B]: [Empty].

Percentage of GDP (%), Domestic revenue: 
2000: 25%; 
2001: 25%; 
2002: 25%; 
2003: 26%; 
2004: 25%; 
2005: 2%7; 
2006: 25%; 
Potential 2009[B]: [Empty].

Percentage of GDP (%), Domestic revenue: Tax income: 
2000: 21%; 
2001: 21%; 
2002: 20%; 
2003: 20%; 
2004: 20%; 
2005: 21%; 
2006: 19%; 
Potential 2009[B]: [Empty].

Percentage of GDP (%), U.S. assistance: 
2000: 18%; 
2001: 17%; 
2002: 18%; 
2003: 18%; 
2004: 20%; 
2005: 15%; 
2006: 20%; 
Potential 2009[B]: [Empty].

Percentage of GDP (%), U.S. assistance: Compact direct assistance: 
2000: 12%; 
2001: 11%; 
2002: 12%; 
2003: 11%; 
2004: 11%; 
2005: 7%; 
2006: 8%; 
Potential 2009[B]: [Empty].

Percentage of GDP (%), U.S. assistance: Discretionary federal programs: 
2000: 6%; 
2001: 6%; 
2002: 6%; 
2003: 7%; 
2004: 9%; 
2005: 8%; 
2006: 12%; 
Potential 2009[B]: [Empty].

Percentage of GDP (%), Other donor assistance: 
2000: 5%; 
2001: 6%; 
2002: 6%; 
2003: 10%; 
2004: 7%; 
2005: 10%; 
2006: 8%; 
Potential 2009[B]: [Empty].

Total expenditures: 
2000: 66%; 
2001: 63%; 
2002: 67%; 
2003: 63%; 
2004: 63%; 
2005: 55%; 
2006: 58%; 
Potential 2009[B]: [Empty].

Operating expenditure: 
2000: 55%; 
2001: 50%; 
2002: 50%; 
2003: 50%; 
2004: 48%; 
2005: 45%; 
2006: 43%; 
Potential 2009[B]: [Empty].

Operating expenditure: Wages and salaries: 
2000: 25%; 
2001: 25%; 
2002: 26%; 
2003: 27%; 
2004: 24%; 
2005: 23%; 
2006: 22%; 
Potential 2009[B]: [Empty].

Capital expenditures: 
2000: 11%; 
2001: 12%; 
2002: 17%; 
2003: 13%; 
2004: 15%; 
2005: 10%; 
2006: 15%; 
Potential 2009[B]: [Empty].

Memo items: Net investments: 
2000: 14%; 
2001: -12%; 
2002: -3%; 
2003: 15%; 
2004: 8%; 
2005: 13%; 
2006: 6%; 
Potential 2009[B]: [Empty].

Memo items: U.S. trust fund withdrawal: 
2000: 0%; 
2001: 0%; 
2002: 4%; 
2003: 4%; 
2004: 4%; 
2005: 4%; 
2006: 3%; 
Potential 2009[B]: [Empty].

Memo items: U.S. cost of compact federal services received: 
2000: 1%; 
2001: 1%; 
2002: 1%; 
2003: 1%; 
2004: 1%; 
2005: 1%; 
2006: 1%; 
Potential 2009[B]: [Empty].

Source: GAO estimates of Palau's single audit data.

Note: All data are for Palau's national government and exclude 
component units. Except for the U.S. cost of compact federal services 
received, population, and GDP, all data for 2000-2006 are based on 
Palau single audits. Years cited are fiscal years (Oct. 1-Sept. 30).

[A] Domestic revenue includes taxes, fees and charges, licenses and 
permits, and other direct revenue, and excludes the net change in the 
fair value of investments.

[B] To estimate potential 2009 domestic revenue and total expenditure, 
we reviewed Palau budgets for 2007 and 2008 and applied the average 
annual growth rate from 2000-2008. To estimate potential 2009 
discretionary federal programs, we reviewed Palau's 2008 budget and 
assumed the same level of programs would be provided in 2009, adjusted 
for inflation. Similarly, we assumed the 2009 level of compact direct 
assistance and U.S. cost of compact federal services would be the 
inflation-adjusted value of those provided in 2008, based on U.S. 
agency budget data.

[C] Discretionary federal programs exclude those provided in kind, such 
as DOD's Civic Action Team program.

[D] Operating expenditure includes current expenditures and debt 
service and excludes investment management fees.

[E] Net investments include the net change in the fair value of 
investments minus investment management fees.

[F] The U.S. cost of compact federal services is based on U.S. agency 
budget data. 

[End of table] 

Table 7: Economic and Fiscal Data for the Three Compact Countries:

Economic statistics, FY 2006[A]: Population; 
Palau: 20,580; 
FSM: 108,000; 
RMI: 52,710.

Economic statistics, FY 2006[A]: GDP per capita: 
Palau: $7,500; 
FSM: $2,190; 
RMI: $2,730.

Economic statistics, FY 2006[A]: GDP (thousands): 
Palau: $154,430; 
FSM: $236,900; 
RMI: $144,140.

Economic statistics, FY 2006[A]: Foreign assistance (thousands)[B]: 
Palau: $44,350; 
FSM: $85,300; 
RMI: $58,500.

Economic statistics, FY 2006[A]: Aid per capita: 
Palau: $2,160; 
FSM: $790; 
RMI: $1,110.

Economic statistics, FY 2006[A]: International visitor arrivals[C]: 
Palau: 82,400; 
FSM: 19,280; 
RMI: 9,170.

Economic statistics, FY 2006[A]: Remittances as a percentage of GDP[C]: 
Palau: -5.5%; 
FSM: 2.5%; 
RMI: 0.3%.

Fiscal statistics, FY 2006[A]: Government tax revenue as a percentage 
of GDP: 
Palau: 19%; 
FSM: 13%; 
RMI: 17%.

Fiscal statistics, FY 2006[A]: Government expenditure as percentage of 
GDP: 
Palau: 58%; 
FSM: 65%; 
RMI: 65%.

Fiscal statistics, FY 2006[A]: Total public sector employee earnings as 
percentage of GDP[D]: 
Palau: 29%; 
FSM: 33%; 
RMI: 36%.

Fiscal statistics, FY 2006[A]: Average public sector wage level ($US): 
Palau: $11,900; 
FSM: $8,850; 
RMI: $11,330.

Fiscal statistics, FY 2006[A]: Average private sector wage level ($US): 
Palau: $6,380; 
FSM: $4,150; 
RMI: $5,070.

Total U.S. assistance levels: Total compact grant assistance provided 
under initial compact (billions)[E]: 
Palau: $0.6; 
FSM: $1.5; 
RMI: $0.7.

Total U.S. assistance levels: Total compact grant assistance provided 
under amended compact (billions)[E]: 
Palau: [Empty]; 
FSM: $1.6; 
RMI: $1.1.

Total U.S. assistance levels: Total U.S. trust fund contribution 
(millions)[F]: 
Palau: $70; 
FSM: $508; 
RMI: $271.

Total U.S. assistance levels: Foreign assistance as percentage of 
national government revenue, 2000-2006 average[B]: 
Palau: 50%; 
FSM: 65%; 
RMI: 64%.

Total U.S. assistance levels: Average annual level of discretionary 
federal programs, 2002-2004 (millions): 
Palau: $9; 
FSM: $45; 
RMI: $20.

Source: Country compact reports, single audit data, and GAO estimates.

[A] All data is rounded to the nearest tenth. Fiscal data for Palau and 
the Republic of the Marshall Islands (RMI) are for the national 
government and for the Federated States of Micronesia (FSM) are for the 
consolidated government, including states. Years cited are fiscal years 
(Oct. 1-Sept. 30).

[B] Excludes in-kind foreign assistance.

[C] Data for remittances and RMI international visitor arrivals is for 
2005.

[D] Total public sector employee earnings include data for the 
national, state, and local governments plus government agencies and 
component units in all three countries.

[E] The initial compact for Palau provided assistance for 15 years. The 
initial compact for the RMI and the FSM provided assistance for 17 
years. Data for U.S. assistance provided under the compacts of free 
association exclude the value of compact federal services and 
discretionary federal programs, but include Kwajalein impact payments 
to the RMI and the U.S. compact road to Palau.

[F] The United States provided funding for a trust fund for Palau under 
the initial compact. The United States provided funding for trust funds 
for the FSM and the RMI under the amended compacts. 

[End of table]

[End of section]

Appendix IV: Technical Notes on the Trust Fund Simulation Model:

This appendix lists the key inputs that we used to simulate the trust 
fund income and balance for 2010 to 2044 and some key simulation 
results. The key inputs include: (1) the trust fund's balances at the 
beginning of the projection, (2) disbursement and inflation adjustment, 
(3) the trust fund balance projection equation, and (4) distribution of 
returns for the Monte Carlo simulation. Further, this appendix contains 
a table comparing the nominal and real compounded returns of a 
portfolio based on the Palau trust fund asset allocation during various 
time periods.

Key Simulation Inputs:

1. Trust Fund Balance at the Beginning of the Projection:

Our projection starts with an account balance of $160.755 million as of 
March 2008. This balance is higher than the projection in the trust 
fund agreement, which shows the account balance at the end of 2008 to 
be $123 million (if disbursement happens at the beginning of the year) 
and $144 million (if disbursement happens at the end of the year). 
However, the projection table in the trust fund agreement contains 
errors. It shows the annual disbursement of $5 million starting from 
the effective date of the compact (1995), rather than from the fourth 
anniversary of the effective date of the compact (1999), as the compact 
calls for. Also, it did not include the additional $4 million U.S. 
contribution, which was made during the third year after the effective 
date of the compact (1997). We corrected these errors and then applied 
the return (12.5 percent) assumed in the trust fund agreement. We 
calculate that this would result in an end of 2008 balance of $268 
million (if disbursement happens at the end of the year) or $259 
million (if disbursement happens at the beginning of the year). These 
were both higher than the actual account balance as of March 2008. We 
also projected the balance at the end of 2009, which is $297 million 
(if disbursement happens at the end of the year) or $285 million (if 
disbursement happens at the beginning of the year); this is far less 
than the projected $390 million that Palau indicated should be in the 
trust fund during its March 2008 meeting with the United States.

2. Disbursement and Inflation Adjustment:

Our projection assumes the disbursement is $15 million a year and the 
disbursement happens on a quarterly basis.[Footnote 78] In their 
projections, both the IMF and the Palau trust fund investment advisor 
assumed that the disbursements are inflation adjusted. However, the 
compact does not specify that the trust fund disbursement be inflation 
adjusted.[Footnote 79]

3. Trust Fund Balance Projection Equation:

In order to project the trust fund balances beyond 2008, we used the 
following projection equation: W_t+1= W_t * (1+r_t)*(1-F_t)-AW_t, where:

W_t+1 = value of the fund at the beginning of period t+1; 
W_t = value of the fund at the beginning of period t; 
r_t = the quarterly return in period t; 
AW_t = the quarterly withdrawal in period t; 
F_t = the fees as a percentage of account value the trust fund pays to 
its trustee, investment advisor, money managers, and lawyers, etc. (We 
assume the fees to be 1 percent of the account value annually.)

4. Distribution of Returns for Monte Carlo Simulation: 

Monte Carlo Simulation: 

Our methodology for projecting trust fund income is based on a 
technique known as the Monte Carlo simulation. This problem-solving 
technique approximates the probability of certain outcomes by 
performing multiple trial runs, called simulations, using random 
variables. The simulations capture the volatility of market returns and 
reflect that volatility in the projection of the future earnings of the 
trust fund. GAO has used the Monte Carlo simulation in past reports, 
including assessments of the FSM and the RMI trust funds, and it also 
has been used by the Congressional Budget Office in Social Security 
projections.

We assume that future returns on the trust fund are randomly drawn from 
custom distributions, which are based on historical nominal returns for 
1970-2007 of the various asset classes and the proportion of the asset 
in the investment strategy. The distributions for small company stocks, 
large company stocks, and U.S. Treasury bills are illustrated in table 
8. The returns were published in Stocks, Bonds, Bills and Inflation 
(SBBI) 2008 Yearbook, by Ibbotson Associates.

Table 8: Nominal Returns Distribution Based on Historical Data, 1970- 
2007:

Small company stocks (%): 

Range: -30.9; -21.56; 
Probability: 2.70. 

Range: -21.56; -19.95; 
Probability: 2.70; 

Range: -19.95; -17.43; 
Probability: 2.70; 

Range: -17.43; -13.28; 
Probability: 2.70. 

Range: -13.28; -9.3; 
Probability: 2.70. 

Range: -9.3; -7.31; 
Probability: 2.70. 

Range: -7.31; -6.67; 
Probability: 2.70. 

Range: -6.67; -5.22; 
Probability: 2.70. 

Range: -5.22; -3.59; 
Probability: 2.70. 

Range: -3.59; 3.11; 
Probability: 2.70. 

Range: 3.11; 4.43; 
Probability: 2.70. 

Range: 4.43; 5.69; 
Probability: 2.70. 

Range: 5.69; 6.85; 
Probability: 2.70. 

Range: 6.85; 10.18; 
Probability: 2.70. 

Range: 10.18; 13.88; 
Probability: 2.70. 

Range: 13.88; 16.17; 
Probability: 2.70. 

Range: 16.17; 16.5; 
Probability: 2.70. 

Range: 16.5; 17.62; 
Probability: 2.70. 

Range: 17.62; 18.39; 
Probability: 2.70. 

Range: 18.39; 20.98; 
Probability: 2.70. 

Range: 20.98; 22.77; 
Probability: 2.70. 
 
Range: 22.77; 22.78; 
Probability: 2.70. 

Range: 22.78; 22.87; 
Probability: 2.70. 

Range: 22.87; 23.35; 
Probability: 2.70. 

Range: 23.35; 23.46; 
Probability: 2.70. 

Range: 23.46; 24.66; 
Probability: 2.70. 

Range: 24.66; 25.38; 
Probability: 2.70. 

Range: 25.38; 28.01; 
Probability: 2.70. 

Range: 28.01; 29.79; 
Probability: 2.70. 

Range: 29.79; 34.46; 
Probability: 2.70. 

Range: 34.46; 39.67; 
Probability: 2.70. 

Range: 39.67; 39.88; 
Probability: 2.70. 

Range: 39.88; 43.46; 
Probability: 2.70. 

Range: 43.46; 44.63; 
Probability: 2.70. 

Range: 44.63; 52.82; 
Probability: 2.70. 

Range: 52.82; 57.36; 
Probability: 2.70. 

Range: 57.36; 60.7; 
Probability: 2.70. 

Large company stocks (%): 

Range: -26.47; -22.1; 
Probability: 2.70.

Range: -22.1; -14.66; 
Probability: 2.70.

Range: -14.66; -11.88; 
Probability: 2.70.

Range: -11.88; -9.11; 
Probability: 2.70.

Range: -9.11; -7.18; 
Probability: 2.70.

Range: -7.18; -4.91; 
Probability: 2.70.

Range: -4.91; -3.17; 
Probability: 2.70.

Range: -3.17; 1.31; 
Probability: 2.70.

Range: 1.31; 4.01; 
Probability: 2.70.

Range: 4.01; 4.91; 
Probability: 2.70.

Range: 4.91; 5.23; 
Probability: 2.70.

Range: 5.23; 5.49; 
Probability: 2.70.

Range: 5.49; 6.27; 
Probability: 2.70.

Range: 6.27; 6.56; 
Probability: 2.70.

Range: 6.56; 7.67; 
Probability: 2.70.

Range: 7.67; 9.99; 
Probability: 2.70.

Range: 9.99; 10.87; 
Probability: 2.70.

Range: 10.87; 14.31; 
Probability: 2.70.

Range: 14.31; 15.8; 
Probability: 2.70.

Range: 15.8; 16.81; 
Probability: 2.70.

Range: 16.81; 18.44; 
Probability: 2.70.

Range: 18.44; 18.47; 
Probability: 2.70.

Range: 18.47; 18.98; 
Probability: 2.70.

Range: 18.98; 21.04; 
Probability: 2.70.

Range: 21.04; 21.41; 
Probability: 2.70.

Range: 21.41; 22.51; 
Probability: 2.70.

Range: 22.51; 23.07; 
Probability: 2.70.

Range: 23.07; 23.84; 
Probability: 2.70.

Range: 23.84; 28.58; 
Probability: 2.70.

Range: 28.58; 28.7; 
Probability: 2.70.

Range: 28.7; 30.55; 
Probability: 2.70.

Range: 30.55; 31.49; 
Probability: 2.70.

Range: 31.49; 32.16; 
Probability: 2.70.

Range: 32.16; 32.42; 
Probability: 2.70.

Range: 32.42; 33.36; 
Probability: 2.70.

Range: 33.36; 37.2; 
Probability: 2.70.

Range: 37.2; 37.43; 
Probability: 2.70.

U.S. Treasury bills (%): 

Range: 1.02; 1.2; 
Probability: 2.70.

Range: 1.2; 1.65; 
Probability: 2.70.

Range: 1.65; 2.9; 
Probability: 2.70.

Range: 2.9; 2.98; 
Probability: 2.70.

Range: 2.98; 3.51; 
Probability: 2.70.

Range: 3.51; 3.83; 
Probability: 2.70.

Range: 3.83; 3.84; 
Probability: 2.70.

Range: 3.84; 3.9; 
Probability: 2.70.

Range: 3.9; 4.39; 
Probability: 2.70.

Range: 4.39; 4.66; 
Probability: 2.70.

Range: 4.66; 4.68; 
Probability: 2.70.

Range: 4.68; 4.8; 
Probability: 2.70.

Range: 4.8; 4.86; 
Probability: 2.70.

Range: 4.86; 5.08; 
Probability: 2.70.

Range: 5.08; 5.12; 
Probability: 2.70.

Range: 5.12; 5.21; 
Probability: 2.70.

Range: 5.21; 5.26; 
Probability: 2.70.

Range: 5.26; 5.47; 
Probability: 2.70.

Range: 5.47; 5.61; 
Probability: 2.70.

Range: 5.61; 5.65; 
Probability: 2.70.

Range: 5.65; 5.8; 
Probability: 2.70.

Range: 5.8; 5.89; 
Probability: 2.70.

Range: 5.89; 6.16; 
Probability: 2.70.

Range: 6.16; 6.35; 
Probability: 2.70.

Range: 6.35; 6.52; 
Probability: 2.70.

Range: 6.52; 6.93; 
Probability: 2.70.

Range: 6.93; 7.18; 
Probability: 2.70.

Range: 7.18; 7.72; 
Probability: 2.70.

Range: 7.72; 7.81; 
Probability: 2.70.

Range: 7.81; 8; 
Probability: 2.70.

Range: 8; 8.37; 
Probability: 2.70.

Range: 8.37; 8.8; 
Probability: 2.70.

Range: 8.8; 9.85; 
Probability: 2.70.

Range: 9.85; 10.38; 
Probability: 2.70.

Range: 10.38; 10.54; 
Probability: 2.70.

Range: 10.54; 11.24; 
Probability: 2.70.

Range: 11.24; 14.71; 
Probability: 2.70.

Source: GAO calculation.

[End of table] 

Cross-correlation and serial correlation are built into the Monte Carlo 
random draws to capture the co-movement across the asset classes and 
over time. (See table 9.)

Table 9: Cross-Correlation and Serial Correlation of Historical Annual 
Returns:

Small company: 
Small company: 1; 
Large company: [Empty]; 
U.S. Treasury bills: [Empty].

Large company: 
Small company: 0.66; 
Large company: 1; 
U.S. Treasury bills: [Empty].

U.S. Treasury bills: 
Small company: -0.01; 
Large company: 0.05; 
U.S. Treasury bills: 1.

Serial correlation: 
Small company: -0.003; 
Large company: 0.03; 
U.S. Treasury bills: 0.81.

Source: GAO calculation. 

[End of table] 

The annual compounded returns and standard deviations for the various 
asset classes are shown in the table 10.

Table 10: Annual Compounded Returns and Standard Deviations for Large 
Company and Small Company Stocks and for U.S. Treasury Bills (in 
percentage), 1970-2007:

Compounded nominal returns: 
Small company: 13; 
Large company: 11; 
U.S. Treasury bills: 6.

Standard deviation: 
Small company: 23; 
Large company: 17; 
U.S. Treasury bills: 3.

Strategic asset allocation in Palau trust fund[A]: 
Small company: 15; 
Large company: 50; 
U.S. Treasury bills: 35.

Source: GAO analysis based on Ibbotson 2008 Yearbook.

[A] This was the strategic asset allocation as of September 2007. It 
may change over time. 

[End of table] 

Monte Carlo Simulation Results:

Each year's return is randomly selected from the return distribution of 
each asset class. The simulation is run 10,000 times, yielding 10,000 
possible outcomes and providing a distribution of annual investment 
income, account balance, and disbursements. (Table 11 shows the first 
20 trial values from the simulation of the trust fund account balance.)

Table 11: Trial Values of the Palau Trust Fund Balance, 2025-2044: 
(Dollars in millions):

Trial value: 1; 
2025: $62; 
2026: $56; 
2027: $48; 
2028: $42; 
2029: $29; 
2030: $18; 
2031: 4; 
2032: 0; 
2033: 0; 
2034: 0; 
2035: 0; 
2036: 0; 
2037: 0; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 2; 
2025: $258; 
2026: $305; 
2027: $337; 
2028: $338; 
2029: $402; 
2030: $442; 
2031: $484; 
2032: $516; 
2033: $589; 
2034: $641; 
2035: $762; 
2036: $915; 
2037: $1,013; 
2038: $1,112; 
2039: $1,304; 
2040: $1,494; 
2041: $1,843; 
2042: $2,134; 
2043: $2,477; 
2044: $2,818.

Trial value: 3; 
2025: $93; 
2026: $75; 
2027: $59; 
2028: $49; 
2029: $44; 
2030: $24; 
2031: $11; 
2032: $1; 
2033: 0; 
2034: 0; 
2035: 0; 
2036: 0; 
2037: 0; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 4; 
2025: $467; 
2026: $509; 
2027: $571; 
2028: $602; 
2029: $677; 
2030: $770; 
2031: $860; 
2032: $843; 
2033: $924; 
2034: $1,121; 
2035: $1,010; 
2036: $1,114; 
2037: $1,202; 
2038: $1,179; 
2039: $1,34; 
2040: $1,184; 
2041: $1,267; 
2042: $1,284; 
2043: $1,540; 
2044: $1,615.

Trial value: 5; 
2025: $193; 
2026: $173; 
2027: $149; 
2028: $143; 
2029: $146; 
2030: $140; 
2031: $147; 
2032: $149; 
2033: $145; 
2034: $163; 
2035: $164; 
2036: $158; 
2037: $150; 
2038: $152; 
2039: $138; 
2040: $130; 
2041: $147; 
2042: $147; 
2043: $152; 
2044: $155.

Trial value: 6; 
2025: $175; 
2026: $174; 
2027: $159; 
2028: $148; 
2029: $122; 
2030: $120; 
2031: $98; 
2032: $68; 
2033: $54; 
2034: $39; 
2035: $30; 
2036: $20; 
2037: $8; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 7; 
2025: $142; 
2026: $131; 
2027: $141; 
2028: $147; 
2029: $131; 
2030: $146; 
2031: $169; 
2032: $160; 
2033: $133; 
2034: $130; 
2035: $125; 
2036: $129; 
2037: $107; 
2038: $97; 
2039: $99; 
2040: $101; 
2041: $110; 
2042: $115; 
2043: $115; 
2044: $118.

Trial value: 8; 
2025: $135; 
2026: $124; 
2027: $130; 
2028: $143; 
2029: $134; 
2030: $152; 
2031: $166; 
2032: $180; 
2033: $177; 
2034: $181; 
2035: $155; 
2036: $161; 
2037: $138; 
2038: $118; 
2039: $123; 
2040: $138; 
2041: $116; 
2042: $119; 
2043: $110; 
2044: $116.

Trial value: 9; 
2025: $428; 
2026: $385; 
2027: $384; 
2028: $431; 
2029: $458; 
2030: $469; 
2031: $413; 
2032: $513; 
2033: $502; 
2034: $579; 
2035: $631; 
2036: $692; 
2037: $683; 
2038: $608; 
2039: $640; 
2040: $686; 
2041: $762; 
2042: $706; 
2043: $753; 
2044: $933.

Trial value: 10; 
2025: $764; 
2026: $872; 
2027: $878; 
2028: $918; 
2029: $1,028; 
2030: $1,087; 
2031: $1,306; 
2032: $1,303; 
2033: $1,344; 
2034: $1,573; 
2035: $1,749; 
2036: $1,860; 
2037: $2,244; 
2038: $2,674; 
2039: $2,925; 
2040: $3,065; 
2041: $3,536; 
2042: $4,022; 
2043: $4,934; 
2044: $4,777.

Trial value: 11; 
2025: $129; 
2026: $111; 
2027: $105; 
2028: $109; 
2029: $86; 
2030: $73; 
2031: $68; 
2032: $63; 
2033: $56; 
2034: $54; 
2035: $44; 
2036: $32; 
2037: $22; 
2038: $8; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 12; 
2025: 0; 
2026: 0; 
2027: 0; 
2028: 0; 
2029: 0; 
2030: 0; 
2031: 0; 
2032: 0; 
2033: 0; 
2034: 0; 
2035: 0; 
2036: 0; 
2037: 0; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 13; 
2025: $139; 
2026: $135; 
2027: $154; 
2028: $131; 
2029: $107; 
2030: $92; 
2031: $91; 
2032: $74; 
2033: $49; 
2034: $40; 
2035: $25; 
2036: $13; 
2037: $1; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 14; 
2025: $424; 
2026: $472; 
2027: $576; 
2028: $605; 
2029: $666; 
2030: $761; 
2031: $767; 
2032: $775; 
2033: $818; 
2034: $972; 
2035: $1,139; 
2036: $986; 
2037: $982; 
2038: $899; 
2039: $1,102; 
2040: $1,235; 
2041: $1,447; 
2042: $1,599; 
2043: $1,896; 
2044: $2,069.

Trial value: 15; 
2025: $58; 
2026: $50; 
2027: $39; 
2028: $32; 
2029: $20; 
2030: $6; 
2031: 0; 
2032: 0; 
2033: 0; 
2034: 0; 
2035: 0; 
2036: 0; 
2037: 0; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 16; 
2025: 0; 
2026: 0; 
2027: 0; 
2028: 0; 
2029: 0; 
2030: 0; 
2031: 0; 
2032: 0; 
2033: 0; 
2034: 0; 
2035: 0; 
2036: 0; 
2037: 0; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 17; 
2025: $37; 
2026: $19; 
2027: $7; 
2028: 0; 
2029: 0; 
2030: 0; 
2031: 0; 
2032: 0; 
2033: 0; 
2034: 0; 
2035: 0; 
2036: 0; 
2037: 0; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 18; 
2025: $80; 
2026: $70; 
2027: $66; 
2028: $60; 
2029: $48; 
2030: $40; 
2031: $23; 
2032: $9; 
2033: 0; 
2034: 0; 
2035: 0; 
2036: 0; 
2037: 0; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 19; 
2025: $14;
2026: $2; 
2027: 0; 
2028: 0; 
2029: 0; 
2030: 0; 
2031: 0; 
2032: 0; 
2033: 0; 
2034: 0; 
2035: 0; 
2036: 0; 
2037: 0; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 20; 
2025: $217; 
2026: $188; 
2027: $156; 
2028: $150; 
2029: $153; 
2030: $127; 
2031: $123; 
2032: $112; 
2033: $100; 
2034: $79; 
2035: $57; 
2036: $50; 
2037: $39; 
2038: $21; 
2039: $6; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: Median; 
2025: $147; 
2026: $144; 
2027: $142; 
2028: $140; 
2029: $135; 
2030: $130; 
2031: $127; 
2032: $122; 
2033: $118; 
2034: $112; 
2035: $106; 
2036: $100; 
2037: $93; 
2038: $84; 
2039: $75; 
2040: $66; 
2041: $56; 
2042: $46; 
2043: $34; 
2044: $22.

Trial value: 10th percentile; 
2025: 0; 
2026: 0; 
2027: 0; 
2028: 0; 
2029: 0; 
2030: 0; 
2031: 0; 
2032: 0; 
2033: 0; 
2034: 0; 
2035: 0; 
2036: 0; 
2037: 0; 
2038: 0; 
2039: 0; 
2040: 0; 
2041: 0; 
2042: 0; 
2043: 0; 
2044: 0.

Trial value: 90th percentile; 
2025: $416; 
2026: $443; 
2027: $469; 
2028: $502; 
2029: $536; 
2030: $576; 
2031: $612; 
2032: $661; 
2033: $708; 
2034: $762; 
2035: $819; 
2036: $887; 
2037: $961; 
2038: $1,025; 
2039: $1,109; 
2040: $1,201; 
2041: $1,304; 
2042: $1,419; 
2043: $1,538; 
2044: $1,649.

Source: GAO analysis.

Note: Years cited are fiscal years (Oct. 1-Sept. 30). 

[End of table] 

Historical Returns of a Portfolio Based on Palau Trust Fund Asset 
Allocation with Various Time Periods:

Forecasts of future returns are subject to considerable uncertainty. 
The historical rates of return for the asset classes held in the fund's 
portfolio differ depending on the time period considered, as 
illustrated in table 12.

Table 12: Historical Rates of Return of a Portfolio Based on the Palau 
Trust Fund Asset Allocation (in percentage):

Period: 1926-2007; 
Nominal Returns: 8.08; 
Rate of Inflation: 3.05; 
Real Returns: 4.86.

Period: 1970-2007; 
Nominal Returns: 9.08; 
Rate of Inflation: 4.62; 
Real Returns: 4.29.

Period: 1988-2007; 
Nominal Returns: 8.88; R
ate of Inflation: 3.04; 
Real Returns: 5.80.

Period: 1998-2007; 
Nominal Returns: 5.23; 
Rate of Inflation: 2.68; 
Real Returns: 2.52.

Source: GAO calculation.

Note: To calculate the compounded returns, we used the annual nominal 
returns published in the Ibbotson Associates 2008 Yearbook. We 
rebalance the portfolio annually to maintain the asset allocation of 50 
percent in U.S. large capital funds, 15 percent in U.S. small capital 
funds, and 35 percent in fixed income assets. The returns are net of 
fees and commissions, which we assume to be 1 percent annually.

[End of table]

[End of section]

Appendix V: Compact Road:

Stakeholders responsible for building a road system on Palau 
encountered challenges in planning and constructing the road, including 
changes in the project's scope, decisions about locating the route, and 
difficult geographical and environmental conditions. In large part 
because of these challenges, the construction of a 53-mile road for 
Palau, which was built to U.S. standards (see fig. 8), was completed 7 
years later than planned. The government of Palau is now responsible 
for the road and faces challenges in managing and funding its operation 
and maintenance. Palau has made some initial efforts to maintain the 
road, but both U.S. and Palau officials are concerned that the 
government of Palau has not sufficiently funded the necessary 
maintenance. Without such maintenance, the road will deteriorate over 
time and may not provide the economic development benefits envisioned 
for the people of Palau.

Figure 8: Compact Road at Beginning and End of Construction:

[See PDF for image] 

This figure contains before and after pictures of the Compact Road. 

Source: USACE. 

[End of figure]

Background:

To assist Palau in its efforts to advance its economic development and 
self-sufficiency, the Compact of Free Association between the United 
States and Palau called for the United States to build a road system 
(compact road) in Palau according to mutually agreed-upon 
specifications before October 1, 2000. The road was completed and 
turned over to Palau on October 1, 2007. While Interior's Office of 
Insular Affairs budgeted $149 million for the project, the cost 
incurred thus far is approximately $144 million.[Footnote 80] Palau 
contributed to the project by preparing, negotiating, and acquiring 
more than 2,000 easements for the road at no cost. U.S. and Palau 
officials expressed their satisfaction with the completed road. 
[Footnote 81]

After completing the compact road, the United States turned it over to 
Palau, which is responsible for operating and maintaining it.[Footnote 
82] In August 2005, the USACE delivered a plan to Palau authorities for 
operating and maintaining the road. The plan provides options for Palau 
to develop maintenance methodologies that can result in the lowest long-
term maintenance costs. The plan also provides options for developing a 
funding mechanism to support the operation and maintenance of the road, 
including a "user pays" concept.

Scope Changes, Route Location Decisions, and Difficult Geographical and 
Environmental Conditions Presented Challenges in Designing and 
Constructing the Road:

According to USACE officials,[Footnote 83] negotiations over the 
project's scope presented challenges in designing the compact road, 
extending the time required to finalize the design. Early in the 
project, Palau requested and negotiated with the United States a change 
that expanded the scope of the project from a 53-mile, 18-foot-wide 
double bituminous surface treatment road[Footnote 84] with 2-foot-wide 
shoulders, as originally agreed, to a 53-mile, 24-foot-wide paved road 
with 4-foot-wide shoulders.[Footnote 85] U.S. legislation passed in 
April 1996 authorized the Secretary of the Interior to agree to 
technical changes to the road, as long as the United States did not 
incur any additional costs, enabling U.S. and Palau stakeholders to 
negotiate changes to the project.[Footnote 86]

Identifying and agreeing on an acceptable route for the compact road 
posed further challenges in designing the project, according to 
Interior and USACE officials. The route had to be approved by the 
government of Palau and meet engineering feasibility requirements. The 
government of Palau eventually decided to build a road to form a ring 
around the island of Babeldaob, providing road access to all 10 states 
on the island (see fig. 9).[Footnote 87] The design also includes a 
spur at the north end of the island.

Figure 9: Map of Palau Roads and States:

[See PDF for image] 

This figure is a map of Palau roads and states, depicting the Compact 
road and other roads. There is also an inset map of the Koror area. 
Areas specifically indicated on the map include: 
Ngarchelong; 
Ngaraard; 
Ngiwal; 
Melekeok; 
Capitol of Palau; 
Ngchesar; 
Airai; 
Palau International Airport; 
Koror; 
Aimeliik; 
Ngatpang; 
Mgaremlengui; 
Ngardmau. 

Source: GAO presentation of Palau Government, USACE, and U.S.Geological 
Survey data. 

[End of figure]

During the project's construction, stakeholders encountered challenges 
associated with Palau's geographic location and environment. Getting 
equipment, materials, and manpower to the island on time proved 
difficult.[Footnote 88] In addition, USACE had to arrange for the 
removal and destruction of 5,500 rounds of ordinance dating from World 
War II during construction. Palau's rugged peak and valley terrain, 
dense jungle, tropical weather, and poor soil quality further 
complicated construction efforts. For example, the valleys had to be 
filled and the hillsides cut in peak areas along the route to create a 
grade for the road consistent with U.S. standards (see fig. 10). 
Tropical rains, combined with the high moisture content of the soils 
used for fill material, made it difficult to get the compaction needed 
to keep the pavement from settling later. In addition, the rain and 
poor soils together caused many landslides, referred to as cut slope 
failures, along the road during construction.[Footnote 89] Such 
failures continued to occur after sections of the road were initially 
completed; however, according to a USACE official, there have been no 
new failures since October 2007, when Palau accepted the compact road 
and assumed responsibility for maintaining it.

Figure 10: Compact Road Construction Terrain and Cut Slope Failure:

[See PDF for image] 

This figure contains two photograph depicting Compact Road construction 
terrain and cut slope failure. 

Source: USACE. 

[End of figure]

Compact Road Was Completed Late but Did Not Exceed USACE's Original 
Cost Estimate:

The compact road--which was to be completed within 6 years of October 
1994, the effective date of the compact between the United States and 
Palau--was turned over to Palau October 2007, 13 years after the 
compact's effective date (see fig. 11). It took almost 2 years from the 
effective date to award design contracts, approximately 2 years to 
design the project, and approximately 9 years to construct the road. 
When we reviewed the site, we found the road completed and open to 
traffic, with only a few deficiencies: For example, the road had 
settled at the end of one bridge and water was seeping out between the 
road and the adjoining shoulder at other locations. USACE is 
investigating the cause of the settlement to determine if it is covered 
by the contractor warranty. In addition, drains are being added along 
the road under the shoulder in water seepage areas to carry water away 
from the road and eliminate the seepage, which could cause future 
maintenance problems by weakening ground support for the road pavement.

Figure 11: Compact Road Project Timeline:

[See PDF for image] 

The timeline depicts the following dates and events: 

1994: 
April: Start-up of project discussed between Interior and USACE; 
October: Effective date of the compact. 

1995:
March: Interior and USACE begin program and project management 
agreement negotiations; 
September: First project cost estimate by USACE; 
October: Interior approved program funding at $149 million; 
November: First road survey contract awarded. 

1996: 
January: First environmental consultant contract awarded; 
April: Congress passes law allowing for project scope change; 
November: Road design consultant contracts awarded. 

[Design phase from late 1996 to late 1998] 

1997: 
August: First geotechnical[A] consultant contract awarded. 

[Construction phase from mid 1998 to mid 2007] 

1998: 
July: Environmental impact statement completed; 
August: Request for proposals for construction issued. 

1999: 
March: Road construction contract awarded; 
June: Partial construction notice to proceed (mobilization); 
November: Full construction notice to proceed. 

2000: 
March: Environmental Quality Protection Board earth-moving permit 
issued; 
October: Compact-specified road completion date. 

2002: 
December: Revised construction contract completion date. 

2003: 
October: Original construction contract completion date. 

2007: 
October: Formal road completion and turnover to Palau. 

2008: 
August: End of road warranty period. 

Source: GAO, Interior, and USACE. 

[A] Geotechnical consultants use borings to analyze the below-ground 
conditions of the soil, rock, and water tables to assist road designers 
in determining how the road should be designed and constructed. 

[End of figure] 

USACE officials reported that U.S. costs for the project were within 
USACE's September 1995 estimate of $149 million.[Footnote 90] That 
estimate was used to create a program budget of $25 million for design 
and design supervision and $124 million for construction and 
construction supervision. While the scope of the project was 
substantially increased, its costs did not exceed USACE's estimate 
because of what an Interior official described as a very competitive 
bidding environment, which allowed the construction contract to be 
awarded at a lower-than-expected cost. Contractors' original 
construction proposals ranged from $73 million to $220 million and a 
contract was awarded for $88.6 million. According to USACE officials, 
construction contract modifications have since increased the cost of 
the construction contract to $107.6 million. In total, USACE has 
expended approximately $138.8 million for the project's design and 
construction, and about $5.1 million in contractual obligations for 
design and construction work remain.[Footnote 91] However, the project 
is currently the subject of a construction contract dispute between the 
United States and the construction contractor, and the final U.S. cost 
of the project cannot be determined until appeals by the construction 
contractor are resolved.[Footnote 92]

Management and Funding Challenges Hinder Palau's Ongoing Efforts to 
Maintain the Road:

Now that the government of Palau, through its Bureau of Public Works, 
is responsible for the compact road's operation and maintenance, it 
faces management and funding challenges. Palau has made initial efforts 
to maintain the road, but U.S. and Palau officials are concerned about 
Palau's ability to provide sufficient funding to maintain the road in a 
condition that supports the desired economic development.

U.S. Government Provided Road Maintenance Training and Operations and 
Maintenance Plan:

Long before turning the compact road over to Palau in October 2007, the 
U.S. government provided Palau with training and a plan for operations 
and maintenance. Specifically, Interior partnered with Palau Community 
College in late 1999 and early 2000 to provide training in road 
maintenance techniques. An Interior official told us that subsequent to 
the initial training, Interior offered additional maintenance training 
using technical assistance funding, but Palau has not taken Interior up 
on the offer. Additionally, in August 2005, USACE--as required by the 
subsidiary construction projects agreement--provided Palau with the 
Operation and Maintenance Plan for the Palau Compact Road. This plan, 
which a USACE consultant developed primarily from information provided 
by an industry group that supports U.S. state highway maintenance 
efforts, includes a strategy and guidance for Palau to develop its own 
detailed program for successfully operating and maintaining the road. 
The plan cautions that unless Palau adopts an aggressive maintenance 
program, the economic development opportunities made possible by the 
compact road will be short lived. Moreover, according to the plan, 
failure to provide timely maintenance will accelerate the road's 
deterioration, and more expensive road reconstruction may then be 
required. The plan estimates annual maintenance costs for the compact 
road that range from $1.5 million to $3 million. Those estimates cover 
the costs of recurrent maintenance tasks such as mowing, sign repair, 
and guardrail repair; overhead such as supervisory personnel, fuel, and 
supplies; capital investments such as equipment and storage yards; 
project maintenance such as asphalt seal coat treatments; and funds for 
natural and man-made disasters and emergencies.[Footnote 93] To 
minimize those costs, the plan recommends using cost-benefit analysis 
to develop least-cost methods of providing the operations and 
maintenance services. The plan also provides options for developing a 
funding mechanism for the operation and maintenance of the compact road 
including a "user pays" concept that would require the government of 
Palau to enact new taxes or increase existing taxes to adequately fund 
the road's operations and maintenance.

Palau Faces Challenges in Managing the Compact Road's Maintenance 
According to the Plan:

The Palau Bureau of Public Works has performed some maintenance 
activities, but not to the degree envisioned in the plan. Specifically, 
Palau workers, 21 of whom are currently assigned to maintain the 
compact road, according to Palau officials, have used string trimmers 
to cut the grass and weeds alongside the road (see fig. 12). During the 
3-month period from November 2007 through January 2008, they trimmed 
approximately 15 of the compact road's 53 miles. This level of 
production would not allow Palau to complete the mowing along the 
entire compact road every 3 months as the plan recommends.

Figure 12: Grass-Cutting Crews and Damaged Guardrail:

[See PDF for image] 

This figure contains two photographs. 

Source: GAO. 

[End of figure]

Palau has not yet begun the full range of operation and maintenance 
activities set out in the plan, such as developing sign inventories, 
inspecting bridges, sealing cracks,[Footnote 94] or requiring permits 
for the public to install driveways, private signs, and other 
obstructions in the road right-of-way. Moreover, the Bureau of Public 
Works could provide only limited documentation of its maintenance 
activities to date, and this documentation did not include records of 
such actions as road maintenance work orders completed, miles of grass 
cut, or numbers of cut slope failures cleaned up.

Our site review of the compact road found the road in very good 
condition except that weeds and grass were overgrowing portions of the 
roadway, potentially obstructing drivers' views in some places. In 
addition, several new private drives were being connected to the 
compact road that did not meet the compact road standards for private 
drives. In one case, a guardrail installed for safety had been removed.

Funding Challenges Limit Palau's Ability to Maintain the Road:

With the compact road, the maintenance workload of the Palau Bureau of 
Public Works has increased, but the budget for the Bureau has 
decreased. The compact road has more than tripled Palau's national road 
miles, increasing their number from 20 to 73. Yet the budget for the 
Bureau of Public Works has decreased from approximately $1.7 million 
for 2007 to about $1.5 million for 2008.[Footnote 95] For 2007, the 
Bureau's Bridge and Road Maintenance Branch had a budget of 
approximately $175,000, and that sum had not changed significantly for 
the last 5 years, according to a Palau official. The Ministry of 
Resources and Development received an additional $300,000 in its 2008 
budget specifically for road maintenance. This funding is separate from 
funding for the Ministry's Bureau of Public Works. Palau officials 
indicated that they plan to use this $300,000 for fuel, supplies, and 
some equipment. The plan suggests a minimum of $1.5 million annually 
for the maintenance of the compact road.

Besides funding routine maintenance, Palau needs to maintain sufficient 
resources to provide emergency maintenance in the event of a typhoon or 
severe rain. Such emergencies may require repairs to bridges and 
drainage pipes, as well as cleanups of cut slope failures, fallen 
trees, and other debris to make the road operational. Between January 
30, 2007 and September 5, 2007, before USACE turned the compact road 
over to Palau, it awarded contracts totaling approximately $334,000 to 
clean up and repair cut slope failures along completed sections of the 
compact road. Such cleanups are now part of Palau's maintenance 
responsibility and must be done if the road is to remain safe and open 
to traffic. A USACE official reported that since September 5, 2007, 
only small soil slides have occurred at sites of previous cut slope 
failures, and the Bureau of Public Works cleaned these up with help 
from a local contractor.

Palau has considered outsourcing some critical road maintenance tasks. 
In May 2007, Palau authorities issued a request for proposals for 
activities such as mowing services for the entire compact road, 
cleaning of bridges and drainage structures, and inspecting culverts 
and bridges. Under this proposal, the contractor would provide all 
equipment and manpower, reducing the need for Palau to purchase 
equipment and hire full-time employees. We found that at least one 
proposal was submitted to Palau to perform these services for 1 year at 
a cost of $371,069. The proposal also indicated how equipment would be 
used and how often maintenance activities would be performed. For 
example, grass would be cut along the entire compact road monthly. 
Palau officials, however, decided not to award a contract for 
maintenance services. Instead, they believed they had enough public 
sector workers to provide maintenance services for the first year.

To help address its maintenance funding challenge, Palau has requested 
additional funding from the United States. In December 2007, Palau 
asked Interior for approximately $1 million to purchase equipment 
listed in the plan to mow, clean, and clear the road. When we asked a 
Palau official about Palau's plan for using the equipment, he said 
Palau does not have a specific plan for the equipment. Palau also had 
not considered the costs to maintain the equipment or how it would be 
utilized to justify its purchase and evaluate the effectiveness of its 
use.[Footnote 96] Palau also asked the United States to set aside a $3 
million debt Palau owes to the United States under section 211(b) of 
the compact to create a capital fund to finance the maintenance of the 
compact road. The U.S. Congress recently passed legislation that 
permits Palau to do so.[Footnote 97]

Assistance in managing and funding the operation and maintenance of the 
compact road is available to Palau through guidance developed for local 
public works agencies in the United States. In contrast to the guidance 
for state highway agencies, on which the USACE consultant based the 
plan, this guidance exists for local public works agencies. With only 
73 miles of road to maintain, such guidance may be more appropriate for 
Palau than the state guidance, and using such guidance may help Palau 
fine tune its compact road operations and maintenance activities and 
budgets. For example, the National Association of County Engineers 
developed a guide for maintenance management and one for road surface 
management. In addition, the Transportation Information Center at the 
University of Wisconsin, Madison, has manuals for simplified road 
pavement surface evaluation. The Federal Highway Administration's Local 
and Tribal Technical Assistance Programs also provide a clearinghouse 
of information and training resources for local agencies responsible 
for roads and bridges. Much of this information is available at no cost 
through the Internet.

[End of section]

Appendix VI: Selected Federal Programs:

This appendix provides additional information on discretionary federal 
programs with expenditures in Palau during 2006. We include additional 
information on selected federal programs to illustrate the diversity of 
U.S. federal program assistance in the areas of education, health, and 
infrastructure. Following the description of selected programs, Table 
13 lists discretionary U.S. federal program funds expended by the Palau 
national government, Palau Community College, and Palau Community 
Action Agency, as reported in the organizations' single audit reports 
for 2006.

Department of Transportation: FAA Airport Improvement Program:

Expenditures:

* 2005: $1.62 million; 
* 2006: $9.40 million.

Recipient: Government of Palau:

Purpose and legislation: The Vision 100-Century of Aviation 
Reauthorization Act (Pub. L. No. 108-176, ï¿½ 188, 117 Stat. 2490, 2519 
(2003)) made sponsors of airports in Palau eligible for grants from the 
Airport Improvement Program discretionary fund and the Small Airport 
Fund for 2004 through 2007. According to an Airport Improvement Program 
coordinator, the purpose of the Airport Improvement Program is to 
create or preserve airport assets and infrastructure. The Airport 
Improvement Program's reauthorization for 2008-2011 is currently 
pending before Congress.[Footnote 98]It contains language that would 
continue Palau's eligibility for funding through this program, and 
preparations are being made in Palau and at FAA to make further 
improvements to the airport if the bill is passed.

Program observations: According to Airport Improvement Program 
managers, Palau's airport runway, prior to the FAA-funded improvements, 
was near closure due to critical aviation safety concerns. Airport 
Improvement Program funds have been used to rehabilitate the runway, 
taxiway, and signage; rehabilitate the airport apron and install two 
additional loading bridges; procure two aircraft rescue and fire- 
fighting vehicles and one rapid intervention vehicle; construct a new 
aircraft rescue and fire-fighting building; install perimeter security 
fencing; and develop an airport master plan. Agency officials told us 
that the Airport Improvement Program's 4-year investment in Palau, from 
2004-2007, totaled approximately $26 million. In commenting on this 
report, FAA noted that the FAA-funded improvements included grant 
assurances agreed to by the Palau government, which require continued 
maintenance and operations for the projected useful life of the 
facilities and equipment. Moreover, they said that the Palau government 
needs to staff the airport with trained and qualified aircraft rescue 
and firefighting personnel. They emphasized the need for safety at 
Palau's airport as U.S. carriers fly to Palau from several locations 
and use it as an emergency airport for overlying routes.

Both agency officials and representatives from the government of Palau 
cited the improvements to the safety and capacity of the airport. 
According to agency officials, Palau has performed well in its 
management of Airport Improvement Program grants because it has 
effectively received competitive bids for projects, made reasonable 
decisions, and tracked grant funds well.

Department of Education: Pell Grants:

Expenditures:

* 2005: $1.83 million; 
* 2006: $2.19 million.

Recipient: Palau Community College through individual students:

Purpose and legislation: Pell Grants, from the Department of Education, 
are intended to provide eligible, undergraduate students with financial 
assistance for educational expenses. The Higher Education Act of 1965, 
as amended (Pub. L. No. 89-329, 79 Stat. 1219), authorized Palau's 
participation.[Footnote 99] Palau's continued eligibility for Pell 
grants after 2009 is contingent on the continued authorization of 
Palau's eligibility for the program in the reauthorization of the 
Higher Education Act.

Program observations: The Pell Grant program provides grants to 
eligible Palauan students, and, because of the low-income levels in 
Palau relative to the United States, most students qualify for the 
program. According to a representative from the community college, the 
Pell Grant program provides a valuable source of student aid and 
assists approximately 550 of the 600 students attending the community 
college. This amounts to a cost of approximately $3,987 per student 
receiving Pell Grant assistance.

Department of Health and Human Services: Head Start:

Expenditures:
* 2005: $1.95 million; 
* 2006: $1.88 million.

Recipient: Palau Community Action Agency:

Purpose and legislation: The Head Start program is designed to provide 
comprehensive child development services to economically disadvantaged 
children and families. The program promotes school readiness by 
assisting low-income children, ages 3-5, with education, health, 
nutrition, medical, and dental services. Omnibus Budget Reconciliation 
Act of 1981, Pub. L. No. 97-35, ï¿½ 636, 95 Stat. 499.

Program observations: Children are eligible to participate in the Head 
Start program based on several criteria, including income levels. 
According to Palau's Head Start representatives, approximately 95 
percent of Palau households qualify by falling under the income level 
threshold, which uses U.S.-based federal income guidelines. The Head 
Start program plays a unique role in Palau's education system as the 
primary pre-school and kindergarten option for most of the nation's 
children. According to government of Palau statistics, approximately 82 
percent of Palau's children enrolled in a pre-school or kindergarten 
are Head Start participants. Palau Head Start maintains 13 educational 
centers located in different areas throughout the country and has a 
funded enrollment level of 509 students, or approximately $3,697 per 
attending child. HHS provides approximately 80 percent of the funding 
for the program and the remaining 20 percent is provided through 
matching funds by the government of Palau or contributed as in-kind 
donations, such as free use of public facilities and parent volunteer 
hours.

Department of Education: Special Education Grants to States:

Expenditures:

* 2005: $0.95 million;
* 2006: $1.08 million.

Recipient: Government of Palau, Ministry of Education:

Purpose and legislation: The Special Education Grants to States is 
provided to local education agencies to help provide special education 
and related services needed to make a free, appropriate public 
education available to children with disabilities. The Individuals with 
Disabilities Education Act (IDEA), Pub. L. No. 91-230, ï¿½ 611, as added 
by Pub. L. No. 108-446, ï¿½ 101, 118 Stat. 2662 (2004) codified at 20 
U.S.C. ï¿½ 1411.

Program observations: The special education program in Palau is managed 
through Palau's Ministry of Education. According to Ministry of 
Education officials, the U.S. Department of Education is the sole 
source of funding for the special education program. The special 
education program is entirely funded through two grants: The Special 
Education Grant to States (Part B) and the Special Education Program 
for Pacific Island Entities (SEPPIE). The Special Education Grant to 
States program provides funding for daily operating expenses while 
SEPPIE funds are used for renovating special education classrooms and 
educating special education teachers. According to Department of 
Education officials, SEPPIE funds are being phased out and future funds 
will be provided under the Part B grant program.

Palau's Ministry of Education has used the funding to establish a 
special education program that serves 193 children, at a cost of 
approximately $5,618 per student, either part time or full time, in 
Palau's 16 elementary schools and one high school. In addition, the 
Ministry of Education has established a memorandum of understanding 
with the local Head Start program in order to identify and serve 
students with disabilities who have not yet entered the formal school 
system.

Department of Health and Human Services: Consolidated Health Centers:

Expenditures:

* 2005: $0.56 million;
* 2006: $0.62 million.

Recipient: Government of Palau, Ministry of Health:

Purpose and legislation: The Consolidated Health Center Program 
promotes the development and operation of community-based primary 
health care service systems in medically underserved areas and improves 
the health status of medically underserved populations. This is a 
competitive, grant-based program. Public Health Service Act, Section 
330(e),(g),(h),(i), as added by Health Centers Consolidation Act of 
1996, Pub. L. No. 104-299, ï¿½ 2, 110 Stat. 3626, 3626-42.

Program observations: The Consolidated Health Center Program plays a 
supporting role in Palau's public health system. The grant originally 
supported 10 small dispensaries located throughout Palau, although 
several of the dispensaries have been consolidated to create four 
"Super Dispensaries" while still maintaining some of the small 
dispensaries on the outlying islands. During calendar year 2006, over 
18,600 patients received services through the grant-supported health 
clinics.

Both U.S. agency officials and officials from the government of Palau 
report that the Consolidated Health Centers Program is important for 
Palau. However, a U.S. agency official stated that the program had two 
weaknesses in its implementation. First, the distinction between the 
health center and the national hospital was not clear. The officials 
found it difficult to tell which patients were being treated by which 
organization. Second, the officials said some of the dispensaries 
outside of Koror were inadequate to meet patients' needs in these areas.

Department of Education: Freely Associated States Education Grants:

Expenditures:

* 2005: $0.57 million;
* 2006: $0.55 million.

Recipient: Government of Palau, Ministry of Education:

Purpose and legislation: The Freely Associated States Education Grant 
(FASEG)[Footnote 100]Program is a competitive direct grant program, 
provided by the Department of Education, to local education agencies in 
Palau and other outlying areas (American Samoa, Guam, the Commonwealth 
of the Northern Marianas Islands) as authorized under the Elementary 
and Secondary Education Act of 1965, Pub. L. No. 89-10, ï¿½ 1121(b) and 
(c), as added by No Child Left Behind Act of 2001, Pub. L. No. 107-110, 
ï¿½ 101, 115 Stat. 1425, 1513 (2002) codified at 20 U.S.C. ï¿½ 6331. The 
grant can be used for teacher training, curriculum development, 
instructional materials, general school improvement or reform, and 
direct educational services. In commenting on this report, Department 
of Education officials noted that Palau's continued eligibility for 
FASEG funds will depend on the outcome of the compact review in 2009. 
Under the definition of an outlying area in the No Child Left Behind 
Act, Palau continues to be eligible for the FASEG program until an 
agreement for the extension of the United States education assistance 
under the Compact of Free Association for each of the freely associated 
states becomes effective after the date of the enactment of the No 
Child Left Behind Act of 2001. (20 U.S.C. ï¿½ 7801 (30)).

Program observations: The FASEG program assists Palau in addressing a 
challenge that was identified by both the U.S. agency officials and 
officials from Palau's Ministry of Education: improving teacher 
quality. According to officials in Palau's ministry, teacher 
qualifications have been decreasing in recent years because of 
mandatory retirement laws that have caused a number of older, qualified 
teachers to retire. FASEG funds address this issue by allowing 
teachers, administrators, and staff to receive training in content 
selection, standards and benchmarks development, teaching strategies, 
educational technology, and other reading and teacher quality programs. 
In 2006, for example, FASEG program funds were used to sponsor a range 
of educational events and trainings, including a Social Studies Test 
Items Development Workshop and a Writing and Reading Workshop.

U.S. Department of Agriculture: Rural Utilities Services 
Telecommunications Loan Program:

Loan Amount: $39.14 million, 4.59 percent interest rate; 
Loan Approved: 1992; 
Loan Due: 2029. 

Recipient: Palau National Communications Corporation (PNCC):

Purpose and legislation: The Rural Electrification Act of 1936, May 20, 
1936, c. 432, 49 Stat. 1363, as amended, authorized the Secretary of 
USDA to make loans for furnishing and improving telephone service in 
rural areas. The loans were intended to be used to furnish, improve, 
expand, construct, and operate telephone service in rural areas. USDA 
Rural Utilities Service made the loan to PNCC.

Program observations: PNCC, a semi-autonomous, governmental agency, 
took out a loan for approximately $39 million in 1992 in an effort to 
improve its telecommunications infrastructure. The loan is set at a 
4.59 percent interest rate and will be paid in full on November 30, 
2029. According to PNCC representatives, the funds were used to lay 
fiber-optic cable throughout Palau and construct an outside switch 
board and switch center. According to U.S. agency officials, the loan 
was secured through a government guarantee and through an established 
escrow fund for 1 year's debt payments. U.S. officials stated that PNCC 
is current on its debt and the outstanding loan balance is 
approximately $31 million.

Both U.S. agency officials and PNCC representatives expressed concern 
regarding PNCC's ability to repay its loan due to increased competition 
in Palau. These officials stated that PNCC is required by law to 
provide universal fixed-line service throughout Palau, and has used the 
revenue generated through its cellular, Internet, and other services to 
support the costs of providing universal fixed-line coverage. According 
to PNCC representatives, outside companies, which are not required to 
offer universal fixed-line service, have entered Palau's cellular and 
long-distance markets, which has reduced PNCC's ability to generate 
revenue. U.S. agency officials and PNCC representatives stated that 
PNCC's ability to repay its loan would be in jeopardy if it continues 
to lose valuable cellular and long-distance customers while maintaining 
expensive universal fixed-line coverage.

Department of Defense Civic Action Teams:

Expenditures:

* 2005: $2.5 million;
* 2006: $2.3 million. 

Purpose and legislation: The compact's implementing legislation, 
Compact of Free Association with Palau, Pub. L. No. 99-658, 100 Stat. 
3672 (1986), states that "in recognition of the special development 
needs of Palau," the United States "shall make available" military 
Civic Action Teams for use in Palau under terms and conditions mutually 
agreed upon by the United States and Palau. An end date for the CATs is 
not stated.

Program observations: The CAT program provides assistance to Palau 
through teams of U.S. military service men and women that carry out 
small-scale infrastructure projects and other projects that support 
socioeconomic development and capacity building. CATs have been active 
in Palau for nearly 40 years. Teams of 13 service men and women, 
primarily engineers, are stationed in Palau for 6-month rotations. The 
teams provide assistance in four main areas: (1) community 
construction, (2) apprentice training, (3) community relations, and (4) 
a medical program. Under the community construction program, the CAT 
members complete small-scale infrastructure projects such as renovating 
community centers, maintaining roads, and building basketball courts. 
Members of the local population--frequently Palau's state governments-
-request specific projects and pay for the raw materials. DOD officials 
stated that occasionally DOD purchased the raw materials because of the 
difficulty in securing funding from the project's sponsor in Palau. In 
2007, CATs in Palau did community construction projects across Palau; 
the projects had a presence in each of Palau's 16 states. While 
conducting these projects, the CATs work with local trainees in an 
apprentice program. These trainees learn construction and mechanic 
trades; others learn administrative or medical skills. CAT members 
assist apprentices with job placement at the end of the program. CAT 
members host community events such as movie nights and tutoring in the 
local schools. Finally, the CAT team offers a free medical clinic to 
the entire community, plus medical outreach to outlying states. DOD 
officials in both Palau and Guam, where operational support is 
conducted, reported that the CATs give U.S. military men and women the 
opportunity to do humanitarian work in a welcoming, positive 
environment. They said the teams are highly visible in Palau and are 
viewed positively by the local population.

Table 13: Discretionary Federal Program Funds Expended in Palau, 2006:

U.S. Agency: DOT-FAA; 
Federal Program: Airport Improvement Program; 
2006 Expenditure: $9,400,475; 
Palau Recipient: Palau National Government.

U.S. Agency: DOT-FAA; 
Federal Program: Total 2006 Program Expenditures; 
2006 Expenditure: $9,400,475. 

U.S. Agency: HHS; 
Federal Program: Head Start; 
2006 Expenditure: $1,881,677; 
Palau Recipient: Palau Community Action Agency.

U.S. Agency: HHS; 
Federal Program: Centers for Disease Control and Prevention--
Investigations and Technical Assistance; 
2006 Expenditure: $1,484,325; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Consolidated Health Centers; 
2006 Expenditure: $618,157; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Substance Abuse and Mental Health Services--Projects 
of Regional and National Significance; 
2006 Expenditure: $309,518; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: National Bioterrorism Hospital Preparedness Program; 
2006 Expenditure: $301,596; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Maternal and Child Health Federal Consolidated 
Programs; 
2006 Expenditure: $269,298; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Epidemiologic Research Studies of Acquired 
Immunodeficiency Syndrome (AIDS) and Human Immunodeficiency Virus (HIV) 
Infection in Selected Population Groups; 
2006 Expenditure: $207,265; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Basic/Core Area Health and Education Center; 
2006 Expenditure: $198,255; 
Palau Recipient: Palau Community College.

U.S. Agency: HHS; 
Federal Program: Maternal and Child Health Services Block Grant to the 
States; 
2006 Expenditure: $197,092; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Family Planning Services; 
2006 Expenditure: $140,969; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Block Grants for Prevention and Treatment of Substance 
Abuse; 
2006 Expenditure: $106,452; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Cooperative Agreements to Support Comprehensive School 
Health Programs to Prevent the Spread of HIV and Other Important Health 
Problems; 
2006 Expenditure: $101,734; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Project Grants and Cooperative Agreements for 
Tuberculosis Control Program; 
2006 Expenditure: $99,112; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Universal Newborn Hearing Screening; 
2006 Expenditure: $80,257; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Immunization Grants; 
2006 Expenditure: $77,287; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Consolidated Knowledge Development and Application 
Program; 
2006 Expenditure: $76,466; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Cooperative Agreements for State-based Diabetes 
Control Programs and Evaluation and Surveillance Systems; 
2006 Expenditure: $67,858; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: HIV Care Formula Grants; 
2006 Expenditure: $64,628; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Block Grants for Community Mental Health Services; 
2006 Expenditure: $50,355; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Preventive Health Services--Sexually Transmitted 
Disease Control Grants; 
2006 Expenditure: $30,737; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Preventive Health and Health Services Block Grant; 
2006 Expenditure: $22,684; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Human Immunodeficiency Virus (HIV)/Acquired 
Immunodeficiency Virus Syndrome (AIDS) Surveillance; 
2006 Expenditure: $17,790; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Civil Rights and Privacy Rule Compliance Activities; 
2006 Expenditure: $11,004; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Injury Prevention and Control Research and State and 
Community Based Programs; 
2006 Expenditure: $2,500; 
Palau Recipient: Palau National Government.

U.S. Agency: HHS; 
Federal Program: Total 2006 Program Expenditures; 
2006 Expenditure: $6,417,016. 

U.S. Agency: Education; 
Federal Program: Pell Grant; 
2006 Expenditure: $2,193,038; 
Palau Recipient: Palau Community College.

U.S. Agency: Education; 
Federal Program: Special Education Grants to States; 
2006 Expenditure: $899,881; 
Palau Recipient: Palau National Government.

U.S. Agency: Education; 
Federal Program: Freely Associated States Education Grant Program; 
2006 Expenditure: $549,401; 
Palau Recipient: Palau National Government.

U.S. Agency: Education; 
Federal Program: Upward Bound Program; 
2006 Expenditure: $359,618; 
Palau Recipient: Palau Community College.

U.S. Agency: Education; 
Federal Program: Upward Bound Math and Science Program; 
2006 Expenditure: $207,487; 
Palau Recipient: Palau Community College.

U.S. Agency: Education; 
Federal Program: Talent Search; 
2006 Expenditure: $203,054; 
Palau Recipient: Palau Community College.

U.S. Agency: Education; 
Federal Program: Special Education Grants to States; 
2006 Expenditure: $184,386; 
Palau Recipient: Palau National Government.

U.S. Agency: Education; 
Federal Program: Student Support Services Program; 
2006 Expenditure: $182,819; 
Palau Recipient: Palau Community College.

U.S. Agency: Education; 
Federal Program: Gaining Early Awareness and Readiness for 
Undergraduate Programs; 
2006 Expenditure: $171,833; 
Palau Recipient: Palau National Government.

U.S. Agency: Education; Federal Program: Vocational Education Basic 
Grants to States; 
2006 Expenditure: $153,304; 
Palau Recipient: Palau National Government.

U.S. Agency: Education; 
Federal Program: Teacher Quality Enhancement Grants; 
2006 Expenditure: $103,527; 
Palau Recipient: Palau National Government.

U.S. Agency: Education; 
Federal Program: Federal Work Study; 
2006 Expenditure: $90,439; 
Palau Recipient: Palau Community College.

U.S. Agency: Education; 
Federal Program: Minority Science; 
2006 Expenditure: $87,899; 
Palau Recipient: Palau Community College.

U.S. Agency: Education; 
Federal Program: Supplemental Educational Opportunity Grant; 
2006 Expenditure: $73,231; 
Palau Recipient: Palau Community College.

U.S. Agency: Education; 
Federal Program: Vocational Education Occupational and Employment 
Information State Grants; 
2006 Expenditure: $53,241; 
Palau Recipient: Palau National Government.

U.S. Agency: Education; 
Federal Program: Adult Education State Grant Program; 
2006 Expenditure: $53,105; 
Palau Recipient: Palau National Government.

U.S. Agency: Education; 
Federal Program: Byrd Honors Scholarships; 
2006 Expenditure: $9,000; 
Palau Recipient: Palau National Government.

U.S. Agency: Education; Federal Program: 
Total 2006 Program Expenditures; 
2006 Expenditure: $5,575,263. 

U.S. Agency: Interior; 
Federal Program: Economic, Social, and Political Development of the 
Territories[A]; 
2006 Expenditure: $2,152,320; 
Palau Recipient: Palau National Government.

U.S. Agency: Interior; 
Federal Program: Total 2006 Program Expenditures; 
2006 Expenditure: $2,152,320.

U.S. Agency: Labor; 
Federal Program: Workforce Investment Act Dislocated Workers Program; 
2006 Expenditure: $159,027; 
Palau Recipient: Palau National Government.

U.S. Agency: Labor; 
Federal Program: Workforce Investment Act Youth Activities; 
2006 Expenditure: $110,150; 
Palau Recipient: Palau National Government.

U.S. Agency: Labor; 
Federal Program: Workforce Investment Act Adult Program; 
2006 Expenditure: $84,400; 
Palau Recipient: Palau National Government.

U.S. Agency: Labor; 
Federal Program: Total 2006 Program Expenditures; 
2006 Expenditure: $353,577.

U.S. Agency: Commerce; 
Federal Program: Special Oceanic and Atmospheric Projects; 
2006 Expenditure: $282,528; 
Palau Recipient: Palau National Government.

U.S. Agency: Commerce; 
Federal Program: Unallied Management Projects; 
2006 Expenditure: $42,333; 
Palau Recipient: Palau National Government.

U.S. Agency: Commerce; 
Federal Program: National Oceanic and Atmospheric Administration 
Donation to IRC Meeting; 
2006 Expenditure: $24,300; 
Palau Recipient: Palau National Government.

U.S. Agency: Commerce; 
Federal Program: Total 2006 Program Expenditures; 
2006 Expenditure: $349,161.

U.S. Agency: USDA; 
Federal Program: Cooperative Forestry Assistance; 
2006 Expenditure: $171,757; 
Palau Recipient: Palau National Government.

U.S. Agency: USDA; 
Federal Program: Community Facilities Loans and Grants; 
2006 Expenditure: $70,619; 
Palau Recipient: Palau National Government.

U.S. Agency: USDA; 
Federal Program: U.S. Department of Agriculture; 
2006 Expenditure: $6,610; 
Palau Recipient: Palau Community College.

U.S. Agency: USDA; 
Federal Program: Total 2006 Program Expenditures; 
2006 Expenditure: $248,986.

U.S. Agency: Energy; 
Federal Program: State Energy Program; 
2006 Expenditure: $423; 
Palau Recipient: Palau National Government.

U.S. Agency: Energy; 
Federal Program: Total 2006 Program Expenditures; 
2006 Expenditure: $423.

U.S. Agency: All Agencies; 
Federal Program: Total 2006 Program Expenditures; 
2006 Expenditure: $24,497,221.

Source: Palau national government, Palau Community College, and Palau 
Community Action Agency single audit reports for 2006.

[A] Interior's programs titled "Economic, Social, and Political 
Development of the Territories" were summed and presented as a single 
program in this table. This number does not include compact direct 
assistance or compact road funding provided by Interior to the 
government of Palau. 

[End of table] 

[End of section]

Appendix VII: Compact Assistance Provided by the Department of the 
Interior:

The following table was taken from the Department of the Interior's 
Office of Insular Affairs budget justification for 2009. It provides 
details on the yearly estimated payments by Interior to Palau over the 
first 15 years of the compact. As illustrated by the table, more than 
half of the compact direct assistance was provided in the first three 
years of the compact. The table also includes information on the 
compact road funding.

Table 16: Compact Assistance Provided by the Department of the 
Interior, Estimated Payments, 1995-2009 (Dollars in thousands):

Activity (P.L. 99-658): Sect. 211(a) Current Account; 
Fiscal Year 1995: $12,000; 
Fiscal Year 1996: $12,000; 
Fiscal Year 1997: $12,000; 
Fiscal Year 1998: $12,000; 
Fiscal Year 1999: $7,000; 
Fiscal Year 2000: $7,000; 
Fiscal Year 2001: $7,000; 
Fiscal Year 2002: $7,000; 
Fiscal Year 2003: $7,000; 
Fiscal Year 2004: $7,000; 
Fiscal Year 2005: $6,000; 
Fiscal Year 2006: $6,000; 
Fiscal Year 2007: $6,000; 
Fiscal Year 2008: $6,000; 
Fiscal Year 2009: $6,000; 
Totals: $120,000. 


Activity (P.L. 99-658): Sect. 211(b) Energy Production;
Fiscal Year 1995: $28,000; 
Fiscal Year 1996: [Empty]; 
Fiscal Year 1997: [Empty]; 
Fiscal Year 1998: [Empty]; 
Fiscal Year 1999: [Empty]; 
Fiscal Year 2000: [Empty]; 
Fiscal Year 2001: [Empty]; 
Fiscal Year 2002: [Empty]; 
Fiscal Year 2003: [Empty]; 
Fiscal Year 2004: [Empty]; 
Fiscal Year 2005: [Empty]; 
Fiscal Year 2006: [Empty]; 
Fiscal Year 2007: [Empty]; 
Fiscal Year 2008: [Empty]; 
Fiscal Year 2009: [Empty]; 
Totals: $28,000. 

Activity (P.L. 99-658): Sect. 211(c) Communications; 
Fiscal Year 1995: $1,650; 
Fiscal Year 1996: $150; 
Fiscal Year 1997: $150; 
Fiscal Year 1998: $150; 
Fiscal Year 1999: $150; 
Fiscal Year 2000: $150; 
Fiscal Year 2001: $150; 
Fiscal Year 2002: $150; 
Fiscal Year 2003: $150; 
Fiscal Year 2004: $150; 
Fiscal Year 2005: $150; 
Fiscal Year 2006: $150; 
Fiscal Year 2007: $150; 
Fiscal Year 2008: $150; 
Fiscal Year 2009: $150; 
Totals: $3,750. 

Activity (P.L. 99-658): Sect. 211(d) Maritime Surveillance, Health, 
Scholarships; 
Fiscal Year 1995: $631; 
Fiscal Year 1996: $631; 
Fiscal Year 1997: $631; 
Fiscal Year 1998: $631; 
Fiscal Year 1999: $631; 
Fiscal Year 2000: $631; 
Fiscal Year 2001: $631; 
Fiscal Year 2002: $631; 
Fiscal Year 2003: $631; 
Fiscal Year 2004: $631; 
Fiscal Year 2005: $631; 
Fiscal Year 2006: $631; 
Fiscal Year 2007: $631; 
Fiscal Year 2008: $631; 
Fiscal Year 2009: $631; 
Totals: $9,465. 

Activity (P.L. 99-658): Sect. 211(e) Start-up for 211(d); 
Fiscal Year 1995: $667; 
Fiscal Year 1996: [Empty]; 
Fiscal Year 1997: [Empty]; 
Fiscal Year 1998: [Empty]; 
Fiscal Year 1999: [Empty]; 
Fiscal Year 2000: [Empty]; 
Fiscal Year 2001: [Empty]; 
Fiscal Year 2002: [Empty]; 
Fiscal Year 2003: [Empty]; 
Fiscal Year 2004: [Empty]; 
Fiscal Year 2005: [Empty]; 
Fiscal Year 2006: [Empty]; 
Fiscal Year 2007: [Empty]; 
Fiscal Year 2008: [Empty]; 
Fiscal Year 2009: [Empty]; 
Totals: $667. 

Activity (P.L. 99-658): Sect. 211(f) Investment Fund[A]; 
Fiscal Year 1995: $66,000; 
Fiscal Year 1996: [Empty]; 
Fiscal Year 1997: $4,000; 
Fiscal Year 1998: [Empty]; 
Fiscal Year 1999: [Empty]; 
Fiscal Year 2000: [Empty]; 
Fiscal Year 2001: [Empty]; 
Fiscal Year 2002: [Empty]; 
Fiscal Year 2003: [Empty]; 
Fiscal Year 2004: [Empty]; 
Fiscal Year 2005: [Empty]; 
Fiscal Year 2006: [Empty]; 
Fiscal Year 2007: [Empty]; 
Fiscal Year 2008: [Empty]; 
Fiscal Year 2009: [Empty]; 
Totals: $70,000. 

Activity (P.L. 99-658): Subtotal Sec. 211: 
Fiscal Year 1995: $108,948; 
Fiscal Year 1996: $12,781; 
Fiscal Year 1997: $16,781; 
Fiscal Year 1998: $12,781; 
Fiscal Year 1999: $7,781; 
Fiscal Year 2000: $7,781; 
Fiscal Year 2001: $7,781; 
Fiscal Year 2002: $7,781; 
Fiscal Year 2003: $7,781; 
Fiscal Year 2004: $7,781; 
Fiscal Year 2005: $6,781; 
Fiscal Year 2006: $6,781; 
Fiscal Year 2007: $6,781; 
Fiscal Year 2008: $6,781; 
Fiscal Year 2009: $6,781; 
Totals: $231,882. 

Activity (P.L. 99-658): Sect. 212(b) Capital Account; 
Fiscal Year 1995: $36,000; 
Fiscal Year 1996: [Empty]; 
Fiscal Year 1997: [Empty]; 
Fiscal Year 1998: [Empty]; 
Fiscal Year 1999: [Empty]; 
Fiscal Year 2000: [Empty]; 
Fiscal Year 2001: [Empty]; 
Fiscal Year 2002: [Empty]; 
Fiscal Year 2003: [Empty]; 
Fiscal Year 2004: [Empty]; 
Fiscal Year 2005: [Empty]; 
Fiscal Year 2006: [Empty]; 
Fiscal Year 2007: [Empty]; 
Fiscal Year 2008: [Empty]; 
Fiscal Year 2009: [Empty]; 
Totals: $36,000. 

Activity (P.L. 99-658): Sect. 213 Defense Use Impact; 
Fiscal Year 1995: $5,500; 
Fiscal Year 1996: [Empty]; 
Fiscal Year 1997: [Empty]; 
Fiscal Year 1998: [Empty]; 
Fiscal Year 1999: [Empty]; 
Fiscal Year 2000: [Empty]; 
Fiscal Year 2001: [Empty]; 
Fiscal Year 2002: [Empty]; 
Fiscal Year 2003: [Empty]; 
Fiscal Year 2004: [Empty]; 
Fiscal Year 2005: [Empty]; 
Fiscal Year 2006: [Empty]; 
Fiscal Year 2007: [Empty]; 
Fiscal Year 2008: [Empty]; 
Fiscal Year 2009: [Empty]; 
Totals: $5,500. 

Activity (P.L. 99-658): Sect. 215 Inflation Adjustment; 
Fiscal Year 1995: $35,719; 
Fiscal Year 1996: $5,842; 
Fiscal Year 1997: $6,075; 
Fiscal Year 1998: $6,440; 
Fiscal Year 1999: $3,790; 
Fiscal Year 2000: $3,861; 
Fiscal Year 2001: $4,004; 
Fiscal Year 2002: $4,147; 
Fiscal Year 2003: $4,147; 
Fiscal Year 2004: $4,290; 
Fiscal Year 2005: $3,752; 
Fiscal Year 2006: $3,936; 
Fiscal Year 2007: $4,121; 
Fiscal Year 2008: $4,305; 
Fiscal Year 2009: $4,490; 
Totals: $98,917. 

Activity (P.L. 99-658): Subtotal; 
Fiscal Year 1995: $186,167; 
Fiscal Year 1996: $18,623; 
Fiscal Year 1997: $22,856; 
Fiscal Year 1998: $19,221; 
Fiscal Year 1999: $11,571; 
Fiscal Year 2000: $11,642; 
Fiscal Year 2001: $11,785; 
Fiscal Year 2002: $11,928; 
Fiscal Year 2003: $11,928; 
Fiscal Year 2004: $12,071; 
Fiscal Year 2005: $10,533; 
Fiscal Year 2006: $10,717; 
Fiscal Year 2007: $10,902; 
Fiscal Year 2008: $11,086; 
Fiscal Year 2009: $11,271; 
Totals: $372,299. 

Activity (P.L. 99-658): Sect. 221(b) Special Block Grant; 
Fiscal Year 1995: $6,300; 
Fiscal Year 1996: $4,900; 
Fiscal Year 1997: $3,500; 
Fiscal Year 1998: $2,000; 
Fiscal Year 1999: $2,000; 
Fiscal Year 2000: $2,000; 
Fiscal Year 2001: $2,000; 
Fiscal Year 2002: $2,000; 
Fiscal Year 2003: $2,000; 
Fiscal Year 2004: $2,000; 
Fiscal Year 2005: $2,000; 
Fiscal Year 2006: $2,000; 
Fiscal Year 2007: $2,000; 
Fiscal Year 2008: $2,000; 
Fiscal Year 2009: $2,000; 
Total: $38,700. 

Activity (P.L. 99-658): Direct payments; 
Fiscal Year 1995: $192,467; 
Fiscal Year 1996: $23,523; 
Fiscal Year 1997: $26,356; 
Fiscal Year 1998: $21,221; 
Fiscal Year 1999: $13,571; 
Fiscal Year 2000: $13,642; 
Fiscal Year 2001: $13,785; 
Fiscal Year 2002: $13,928; 
Fiscal Year 2003: $13,928; 
Fiscal Year 2004: $14,071; 
Fiscal Year 2005: $12,533; 
Fiscal Year 2006: $12,717; 
Fiscal Year 2007: $12,902; 
Fiscal Year 2008: $13,086; 
Fiscal Year 2009: $13,271; 
Total: $410,999. 

Activity (P.L. 99-658): Federal services[B]; 
Fiscal Year 1995: $0; 
Fiscal Year 1996: $0; 
Fiscal Year 1997: $0; 
Fiscal Year 1998: $0; 
Fiscal Year 1999: $0; 
Fiscal Year 2000: $0; 
Fiscal Year 2001: $0; 
Fiscal Year 2002: $0; 
Fiscal Year 2003: $0; 
Fiscal Year 2004: $0; 
Fiscal Year 2005: $0; 
Fiscal Year 2006: $0; 
Fiscal Year 2007: $0; 
Fiscal Year 2008: $0; 
Fiscal Year 2009: $0; 
Total: $0. 

Activity (P.L. 99-658): Sect. 212(a) Palau Road Construction; 
Fiscal Year 1995: $53,000; 
Fiscal Year 1996: [Empty]; 
Fiscal Year 1997: $96,000; 
Fiscal Year 1998: [Empty]; 
Fiscal Year 1999: [Empty]; 
Fiscal Year 2000: [Empty]; 
Fiscal Year 2001: [Empty]; 
Fiscal Year 2002: [Empty]; 
Fiscal Year 2003: [Empty]; 
Fiscal Year 2004: [Empty]; 
Fiscal Year 2005: [Empty]; 
Fiscal Year 2006: [Empty]; 
Fiscal Year 2007: [Empty]; 
Fiscal Year 2008: [Empty]; 
Fiscal Year 2009: [Empty]; 
Totals: $149,000. 

Activity (P.L. 99-658): Grand total, Palau; 
Fiscal Year 1995: $245,467; 
Fiscal Year 1996: $23,523; 
Fiscal Year 1997: $122,356; 
Fiscal Year 1998: $21,221; 
Fiscal Year 1999: $13,571; 
Fiscal Year 2000: $13,642; 
Fiscal Year 2001: $13,785; 
Fiscal Year 2002: $13,928; 
Fiscal Year 2003: $13,928; 
Fiscal Year 2004: $14,071; 
Fiscal Year 2005: $12,533; 
Fiscal Year 2006: $12,717; 
Fiscal Year 2007: $12,902; 
Fiscal Year 2008: $13,086; 
Fiscal Year 2009: $13,271; 
Total: $559,999. 

Source: Department Of The Interior, Office Of Insular Affairs. 

[A] Palau may withdraw $5 million annually from the fund in years 5 
through 15. 

[B] Aggregate amount included on the FSM/RMI Compact Estimated Amounts 
table for federal services for FSM/RMI/Palau. 

[End of table] 

[End of section] 

Appendix VIII: Comments from the Department of Interior: 

The Associate Deputy Secretary Of The Interior: 
Washington: 

May 28, 2008: 

Mr. David Gootnik: 
Director, International Affairs and Trade: 
United States Government Accountability Office: 
441 G Street, NW: 
Washington D.C. 20548: 

Dear Mr. Gootnik: 

Thank you for the opportunity to review and comment on the draft 
Government Accountability Office Report entitled, "Compact Of Free 
Association. Palau's Use of and Accountability for U S. Assistance and 
Prospects for Economic Self-Sufficiency," (GAO-08-732). The Department 
of the Interior finds the Report very useful as we prepare for the 
required Compact review between the United States and Palau. The Report 
provides key information upon which to discuss future Executive Branch 
policy. 

The Department accepts the recommendation to formally consult with 
Palau regarding Palau's financial management challenges and to assist 
Palau in building financial management capacity. We have already had 
preliminary discussions with our training partner, the U.S. Department 
of Agriculture Graduate School, to implement a program of leadership 
and succession planning for key positions in the island governments. We 
will address Palau's needs specifically as part of the Compact review. 

Thank you again for the opportunity to comment on the Report. If you 
have any questions concerning the response, please communicate with 
Nikolao Pula, Director of the Office of Insular Affairs, at (202) 208-
4736. 

Sincerely, 

Signed by: 

James E. Cason: 

[End of section] 

Appendix IX: Comments from the Republic of Palau: 

Republic of Palau: 
Office of the President: 
Tommy E. Remengesau, Jr., President:
P.O. Box 6051, Palau, PW 96940: 
Tel. (680)767-2403/2828: 
Fax. (680)767-2424/1662: 
email-IN:[email protected]: 

May 13, 2008: 
Serial No. 08-117: 

David B. Gootnick: 
Director, International Affairs and Trade: 
U.S. Government Accountability Office: 
441 G Street N.W. 
Washington D.C. 20548: 

Subject: Response to Draft GAO Report No. GAO-08-732: 

Dear Mr. Gootnick: 

Along with appropriate Executive Branch staff, I have reviewed your 
draft GAO Report, dated June 2008, and, on behalf of the President of 
the Republic of Palau, make the comments that follow. I intend to limit 
my comments to issues that are appropriately related to the scope of 
the Daft Report, which included (1) the provision of Compact and other 
U.S. assistance to Palau in 1995-2009, (2) Palau's and U.S. agencies' 
efforts to provide accountability over Palau's use of federal funds in 
1995-2006, and (3) Palau's prospects for achieving economic self-
sufficiency. 

I. 1995-2009 Compact Assistance: 

In general terms, Palau concurs with the economic analyses and figures 
set forth in the Draft Report. Palau would, however stress that Palau 
entered the Compact period in a position of extreme reliance on United 
States assistance. Total assistance flows in the initial years of the 
Compact were exceptionally high relative to the size of the economy and 
were in excess of 36 percent of GDP and represented roughly 64 percent 
of current expenditures at that time. Since that time, Palau has 
gradually-but persistently-become less reliant. As of Fiscal Year 2007, 
total United States assistance was equal to approximately 16 percent of 
GDP (inclusive of the $5 million drawdown allowed from the Compact 
Trust Fund), and United States assistance represented 41 percent of 
current expenditures. 

II. Accountability: 

In the area of accountability, Palau once again concurs with the 
general findings of the Draft Report. Palau has, indeed, made 
significant progress, as reflected in recent single audit reports. In 
fact, Palau was the first of the insular and FAS governments to achieve 
an unqualified audit opinion of its financial statements; having 
achieved that in Fiscal Year 2003 and in each subsequent year. 

That being said, Palau also recognizes that there are factors related 
to continuing fiscal constraints that hinder our ability to sustain the 
progress that we have made. Despite the fact that the Office of Insular 
Affairs, within the Department of Interior, has provided support to 
Palau's on-going efforts to improve its financial management capacity 
through the PITI/VITI Program (Pacific Islands Training Initiative/ 
Virgin Islands Training Initiative) and the FMIP (Financial Management 
Improvement Program), the inability of the Ministry of Finance to 
recruit and maintain qualified personnel associated with ongoing fiscal 
constraints, as well as the non-competitive civil service compensation, 
creates significant challenges for the Republic. 

Palau agrees with the report finding that documentation of required 
annual economic consultations was lacking; however, Palau did benefit 
significantly from nearly annual economic consultations and did take 
those meetings as opportunities to address important economic 
performance and policy matters. Perhaps even more benefit was derived 
from our ongoing, but informal, interactions with lead U.S. government 
officials. In the future, Palau will undertake to take the lead on 
documenting mandated consultations for the record, so that Palau will 
ensure full compliance with current and future Compact requirements. 

Palau also supports the Draft Report's recommendation for the Office of 
Insular Affairs (OIA) to continue to assist Palau in building financial 
management capacity. However, for this assistance to be effective, 
Palau intends to establish an on-going institutional strengthening 
program that focuses on human resource development and improved 
retention of key personnel to insure that financial management 
improvements are sustainable. 

III. Achieving Self Sufficiency: 

Once again, the Republic concurs with the primary findings of the Draft 
Report relating to Palau's prospects for achieving economic self-
sufficiency. While Palau has made real progress over the last fourteen 
years on overall reliance on U.S. direct and federal funding 
assistance, these funding sources remain a significant and critical 
funding resource to the Republic, particularly for health and education 
program expenditures. Taken together, the loss of direct assistance, as 
partially replaced by annual Trust Fund withdrawals, the potential loss 
of discretionary federal programs and the potential loss of federal 
services (postal, weather and aviation services) would have a dramatic 
negative impact on Palau's efforts to continue to move towards self-
sufficiency. 

In addition, Palau concurs with the Report's analysis of the Trust Fund 
and its potential depletion after 2016. Combined with the adverse 
impact from the diminishing inflation-adjusted value of the Trust Fund, 
failure to sufficiently capitalize the Trust Fund could lead to dire 
economic consequences. 

Regarding the issue of fiscal reform, Palau recognizes that ultimate 
self-sufficiency can only result from the effective implementation of 
rigorous economic reforms. As part of an overall structural reform 
program, Palau is currently looking to establish a medium-term fiscal 
framework that, assuming a recapitalized Trust Fund, over ten years, 
calls for operational expenditure reductions and domestic revenue 
increases that, together, will result in current expenditures being 
funded primarily from domestic resources. 

Finally, Palau understands that the private sector will need to grow to 
offset and support overall economic growth in the face of necessary 
fiscal adjustments over the medium-to-long term. As employment in 
public administration contracts and as current government expenditures 
decline as a share of GDP, an enhanced private sector policy framework
will be needed to support private sector expansion. Policy commitments 
in this regard will likely include: 

* Undertaking comprehensive tax reform;
* Overhauling foreign investment regulations;
* Reviewing and reforming the legal system for commercial activities;
* Reforming the financial market;
* Land reform; and; 
* Articulating and implementing high end tourism policies. 

Palau understands that a number of issues are beyond the scope of your 
report. In particular, Palau would note that there are important 
strategic and economic benefits to the United States from (a) Palau's 
contributions as a strong ally of the United States in security and 
diplomatic matters including the U.S. military service of its youth and 
its strategic location in the Pacific and (b) the significant world 
wide leadership that Palau provides on environmental matters, 
particularly those related to preservation of its maritime treasures. 
The economic costs of these efforts are not directly reflected in 
Palau's economic performance or the scope of the GAO report. 

On behalf of President Tommy E. Remengesau, Jr., I would like to thank 
you and the staff of the GAO for its very thorough analysis of the 
issues relating to Palau presented in your report to the U.S. Congress. 
If you have any further questions regarding these very pressing issues, 
please feel free to present them for our immediate response. 

Sincerely, 

Signed by: 
Billy G. Kuartei: 
Chief of Staff: 
Republic of Palau: 

[End of section] 

Appendix X: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

David Gootnick, 202-512-3149 or [email protected]: 

Staff Acknowledgements: 

In addition to the individual named above, Emil Friberg, Assistant 
Director; Kate Brentzel; Ming Chen; Cheryl Clark; Leslie Locke; Matthew 
Reilly; Kendall Schaefer; and Doris Yanger made key contributions to 
this report. Reid Lowe and Grace Lui provided technical assistance. 

[End of section] 

Footnotes: 

[1] Unless otherwise noted, all years cited are fiscal years (Oct. 1- 
Sept. 30). Because the compact entered into force on Oct. 1, 1994, U.S. 
assistance under the compact began in fiscal year 1995. 

[2] The compact's federal programs and services agreement establishes 
the terms under which the U.S. government provides compact federal 
services--postal, weather, and aviation--to Palau (see Federal Programs 
and Services Agreement Concluded Pursuant to Article II of Title Two 
and Section 232 of the Compact of Free Association). The agreement, 
which took effect in 1995, expires at the end of 2009; unless it is 
renewed or extended, the provision of compact federal services will not 
continue. The agreement sets up the legal status of programs and 
related services, federal agencies, U.S. contractors, and personnel of 
U.S. agencies implementing both compact federal services and 
discretionary federal programs. The agreement does not mandate the 
provision of discretionary programs in Palau. U.S. legislation 
establishes Palau's eligibility for these programs, with funding for 
the programs appropriated by Congress. The impact of the agreement's 
expiration in 2009 on discretionary programs' operation in Palau is 
uncertain. The level of discretionary federal program funding after 
2009 also depends on Palau's program eligibility status and the 
availability of appropriations; changes in either factor may increase 
or reduce the amounts received. 

[3] Agreement Concerning Procedures for the Implementation of United 
States Economic Assistance, Programs and Services Provided in the 
Compact of Free Association Between the Government of the United States 
and the Government of the Republic of Palau. 

[4] The compact required the United States to set up the trust fund 
with an initial investment of $66 million in 1995 and an additional $4 
million in 1997. The compact stated that the trust fund's objective was 
to produce an average annual distribution of $15 million starting in 
2010 for 35 years. It also stated that $5 million shall be distributed 
annually from the fund for Palau's current account operations and 
maintenance, starting in 1999. Under the compact's trust fund 
agreement, Palau, in its management of the fund, agreed to be guided by 
distributions set forth in a table, which set forth goals for the 
minimum and maximum amounts of annual distribution (see Agreement 
Between the Government of the United States and the Government of Palau 
Regarding Economic Assistance Concluded Pursuant to Section 211(f) of 
the Compact of Free Association). 

[5] The National Weather Service is part of the National Oceanic and 
Atmospheric Administration within the Department of Commerce. 

[6] In this report, "compact direct assistance" refers to the grants 
enumerated in sections 211-215 and section 221(b) of the compact. For 
further details, see table 2. 

[7] All dollar amounts in this report are in current (i.e., nominal) 
dollars. 

[8] All trust fund return rates in this report are net of fees and 
commissions, unless otherwise stated. 

[9] In 1994, the United Nations concluded that the United States had 
satisfactorily discharged its obligations as administering authority of 
the Trust Territory of the Pacific Islands. 

[10] After growing strongly in the first few years of the compact, 
Palau's GDP declined in 1999 and stagnated until 2003 due, in part, to 
negative impact on its tourism sector from the 1999 Asian Financial 
Crisis and the September 11, 2001 terrorism attacks. Growth resumed in 
2004. Per capita GDP estimates include both Palauan-born citizens and 
foreign workers. 

[11] This estimate excludes substantial in-kind foreign assistance from 
donors, often for infrastructure projects. Foreign-funded projects 
include the U.S.-funded compact road, the Japanese-funded Friendship 
Bridge connecting Babeldaob to Koror, and the Taiwanese-funded 
agricultural technical mission. 

[12] Data on foreign workers are from Palau's Social Security office 
and exclude workers not registered with the office. 

[13] See Proclamation 6726 Placing into Full Force and Effect the 
Compact of Free Association with the Republic of Palau, 59 Fed. Reg. 
49777 (Sept. 27, 1994). 

[14] The 15-year term is from 1995 to 2009. 

[15] The U.S. government may audit the funds directly or use an 
external public auditor; in either case, the audits are conducted at no 
cost to the government of Palau. The U.S. government's authority to 
audit compact funds continues for at least 3 years after the last 
element of assistance has been provided and expended. 

[16] All nonfederal entities that expend more than a threshold amount 
($500,000 as of 2004) in federal awards in a year are required to 
obtain an annual audit in accordance with the Single Audit Act, 
codified, as amended at 31 U.S.C. Chp. 75. Single audits are audits of 
the recipient organization--in Palau, the national government and other 
component units--that focus on the recipient's financial statements, 
internal controls, and compliance with laws and regulations governing 
federal grants. One of the objectives of the act is to promote sound 
financial management, including effective internal controls, with 
respect to federal expenditures of the recipient organization. Single 
audit reports include the auditor's opinion on the audited financial 
statements and a report on the internal controls related to financial 
reporting. The single audit reports also include the auditor's opinion 
on compliance with requirements of major federal programs and a report 
on internal controls related to compliance with laws, regulations, and 
the provisions of contracts or grant agreements. 

[17] Office of Management and Budget (OMB) Circular No. A-133, Audits 
of States, Local Governments, and Non-Profit Organizations, establishes 
policies for federal agencies to use in implementing the Single Audit 
Act and provides an administrative foundation for consistent and 
uniform audit requirements for nonfederal entities administering 
federal awards. 

[18] Although all federal awarding agencies are responsible for 
ensuring that single audit reports are completed in accordance with OMB 
Circular No. A-133 and are received in a timely manner, one of the 
award-making agencies--usually the agency that provides the largest 
amount of funding--is designated as the cognizant agency, with specific 
responsibilities under OMB Circular No. A-133. Cognizant agencies' 
additional responsibilities include coordinating management decisions 
for audit findings that affect the audit programs of more than one 
agency and considering auditee requests for extensions to the due dates 
of the reports. 

[19] As a member of Palau's audit resolution team, the Office of the 
Public Auditor is responsible for (a) monitoring each affected agency 
with a single audit finding or questioned cost, (b) performing follow- 
up on corrective actions, and (c) reporting to Interior's OIG regarding 
audit findings and questioned costs that have been effectively 
resolved. The Office of the Public Auditor also is involved in ensuring 
that Palau's component units finalize their audits in time for 
inclusion in Palau's single audit report. 

[20] Other U.S. agencies' discretionary federal grant programs have 
accountability requirements that are specific to those programs. We did 
not assess Palau's compliance with these requirements. However, Palau's 
expenditure of federal grants is included in the single audits; these 
audits review Palau's compliance with federal program requirements. 

[21] According to Executive Order 12569 of 1986, reprinted in 51 Fed. 
Reg. 37171 (Oct. 16, 1986), Interior is responsible for ensuring that 
the economic and financial assistance provided by the compact is made 
available to Palau as well as for monitoring any program or activity 
provided to Palau by all U.S. agencies except DOD; State is responsible 
for government-to-government relations between the United States and 
Palau. 

[22] Palau is required to submit these economic development plans every 
5 years during the duration of title two of the compact. 

[23] Title three of the compact also includes a requirement for 
consultations between the United States and Palau. It requires the U.S. 
and Palau governments to establish a joint committee to discuss any 
disputes over the security and defense provisions of the compact. The 
joint committee is required to meet semiannually unless otherwise 
mutually agreed. 

[24] Some of the financial data presented for discretionary federal 
programs in this report were extracted from Palau's audited financial 
statements for 1995-2006; the statements for 1995-2002 received 
qualified opinions from external auditors. Therefore, these figures are 
subject to the limitations cited by the auditors in their opinions and 
to the material internal control weaknesses identified. 

[25] The compact states that the amounts specified in sections 211-215 
are "backed by the full faith and credit of the United States," which 
legally guarantees funding. 

[26] Palau includes an account of its implementation of direct 
assistance in the compact annual reports it submits to the U.S. 
government. 

[27] Although the compact states that Palau shall receive $2 million 
per year in 211(b) funding, a related agreement--Agreement Concerning 
Special Programs Related to the Entry into Force of the Compact of Free 
Association Between the Government of the United States and the 
Government of the Republic of Palau--specified that the United States 
would fulfill this commitment with a lump sum deposit of $28 million in 
the first year the compact went into effect, i.e. fiscal year 1995, 
plus an inflation adjustment of $12 million. The agreement requires 
Palau to pay $3 million to the United States by September 30, 2005, as 
a net economic cost to the United States for making the $28 million 
available to Palau in the first year of the compact. In its 2005 annual 
report, Palau reported that an official request had been made to 
utilize the $3 million to establish a capital fund for compact road 
maintenance. The U.S. Congress recently passed legislation that permits 
Palau to retain the $3 million to set up a trust fund for compact road 
maintenance, as long as the fund is established and operated pursuant 
to an agreement entered into between the U.S. government and the 
government of Palau. See Pub. L. No. 110-229, Title VIII, Sec. 808, 122 
Stat. 874 (May 8, 2008). 

[28] Section 215 states that the amounts stated in sections 211(a), 
211(b), 211(c), and 212(b) shall be adjusted for each fiscal year by 
the percent which equals two-thirds of the percentage change in the 
United States Gross National Product Implicit Price Deflator, or 7 
percent, whichever is less in any 1 year, using fiscal year 1981 as the 
base. 

[29] These services are provided under section 221 of title two of the 
compact. The United States provides in-kind contributions for the 
postal and aviation services and reimburses the government of Palau for 
the cost of operating its weather station. 

[30] Palau operates its own postal service for internal mail 
distribution, and transports mail to and from air and sea ports for 
international shipment, at which point USPS takes responsibility. 

[31] The federal programs and services agreement states that after the 
effective date of the compact, USPS may establish cost-related rates 
for mail from the United States to Palau. A USPS official said that 
State officials told USPS that raising the rates could have a negative 
effect on the compact's goal of establishing Palau's economic self- 
sufficiency, so USPS kept the postal rates the same as U.S. domestic 
rates. 

[32] USPS relies on contracted commercial air service for airmail 
shipment to Palau. 

[33] FAA provides the following services to Palau: en-route air traffic 
control from the Oakland, California airport, maintenance of 
nondirectional beacon and distance measuring equipment at Palau's 
airport; maintenance of precision approach path indicator lighting 
system and runway end identifier lights at Palau's airport; flight 
inspection of airport navigational aids; development of instrument 
approach and departure procedures; and technical assistance and 
training. 

[34] This figure is based, in part, on information obtained in the 
single audits for 1995 through 2006 for the three primary recipients of 
U.S. federal grants in Palau: the Palau national government, the Palau 
Community College, and the Palau Community Action Agency. At the time 
of this report, audited financial data for 2007 were not yet available. 

[35] The Palau Community College is the only postsecondary school in 
Palau. 

[36] TRIO grant-based programs are educational and opportunity outreach 
programs designed to support students from disadvantaged backgrounds. 

[37] The Upward Bound program, part of the TRIO programs, is designed 
to provide support for participants to succeed in their precollege and 
higher education pursuits. 

[38] According to U.S. agency officials, the Palau Community Action 
Agency has been the sole grantee and Head Start service provider for 
the 40 years the program has existed in Palau. 

[39] With the exception of DOD's CAT program, our analysis did not 
quantify the value of this additional U.S. assistance and it is not 
included in the discretionary federal program total of $266.7 million 
in figure 3 or U.S. agency expenditures in figure 4. 

[40] We did not attempt to estimate the cost of Peace Corps's presence 
in Palau from 1995-2009. 

[41] Our analysis did not attempt to quantify the value of U.S. agency- 
provided development loans, and this value is not included in the 
discretionary federal program total of $266.7 million in figure 3 or 
U.S. agency expenditures in figure 4. 

[42] Under the Single Audit Act, the single audit reporting package is 
generally required to be submitted to the Federal Audit Clearinghouse, 
which is an automated database of single audit information, either 30 
days after the receipt of the auditor's report or 9 months after the 
end of the period under audit. 

[43] At the time of this report, Palau's fiscal year 2007 single audit 
report had not been submitted and is not due for submission until June 
30, 2008. 

[44] Auditors are required by the Single Audit Act and OMB Circular No. 
A-133 to provide an opinion (or disclaimers of opinion, as appropriate) 
as to whether financial statements are presented fairly in all material 
respects in conformity with generally accepted accounting principles. 
Generally accepted accounting principles are the conventions, rules, 
and procedures that provide the norm for fair presentation of financial 
statements. Auditors render a qualified opinion when they identify one 
or more specific matters that affect the fair presentation of the 
financial statements. The effect of the auditors' qualified opinion can 
be significant enough to reduce the usefulness and reliability of the 
financial statements. 

[45] Sound internal control over financial reporting is needed to 
adequately safeguard assets; ensure that transactions are properly 
recorded; and prevent or detect fraud, waste, and abuse. 

[46] The 2006 single audit report cited five material weaknesses and 
nine reportable conditions in internal control over financial 
reporting. Reportable conditions are related to significant 
deficiencies in the design or operation of internal controls that could 
adversely affect the audited entity's ability to produce financial 
statements that fairly represent the entity's financial condition. 
Material weaknesses are reportable conditions in which the design or 
operation of internal controls does not reduce to a relatively low 
level the risk that misstatements caused by error or fraud--material in 
relation to the financial statements being audited--may occur and not 
be detected in a timely period by employees in the normal course of 
performing their duties. The material weaknesses cited in the 2006 
report included (1) lack of supporting documentation to support travel 
expenditures; (2) lack of review of monthly bank reconciliations and 
nonresolution of reconciling differences; (3) lack of policies and 
procedures to reconcile accounts receivable and prepayments; and (4) 
lack of adherence to prescribed travel policies and procedures. 

[47] In addition to requiring auditors to assess financial statements, 
the Single Audit Act and OMB Circular No. A-133 require auditors to 
determine and express an opinion as to whether the auditee has complied 
with laws, regulations, and the provisions of contracts or grant 
agreements that may have a direct and material effect on each of its 
major federal programs. Auditors are to identify the applicable 
compliance requirements to be tested and reported on in a single audit. 
OMB's Compliance Supplement lists and describes the types of compliance 
requirements and related audit objectives and suggested audit 
procedures that auditors should consider in single audits conducted in 
accordance with OMB Circular No. A-133. When auditors identify 
instances of noncompliance, they are required to report whether the 
noncompliance could have a direct and material effect on a major 
federal program. 

[48] Of the internal control weaknesses reported in 2006, 15 were 
reportable conditions and 1 was considered material. In the context of 
compliance, reportable conditions are matters that come to an auditor's 
attention related to significant deficiencies in the design or 
operation of internal controls over compliance that could adversely 
affect the entity's ability to operate a major federal program within 
the applicable requirements of laws, regulations, contracts, and 
grants. Material weaknesses in this context are reportable conditions 
in which internal controls do not reduce to a relatively low level the 
risk of noncompliance with applicable requirements of laws, 
regulations, contracts, and grants that would be material to the major 
federal program being audited and undetected in a timely way by 
employees in the normal course of performing their duties. 

[49] The 2006 report stated that this particular weakness is caused by 
a decentralized, fixed asset accounting division that appears to be 
disassociated from the rest of the accounting function, resulting in a 
process with little coordination, review, and monitoring. 

[50] According to the 2006 single audit report, Palau's plans to 
address the report's findings about its compliance with, and internal 
control over compliance with, federal program requirements also include 
reconciling, reporting, and resolving differences related to its 
federal grants receivable balances with federal grantor agencies; 
ensuring that expenditures charged to federal programs are directly 
related to program goals and objectives; strengthening internal 
controls over program budget documentation, to ensure budgeted 
allotments agree with program objectives; and improving compliance with 
period of federal grant availability requirements. 

[51] DOD officials also reported, and provided documentation of, annual 
meetings between DOD and the government of Palau to discuss security 
and defense issues pertinent to title three of the compact. The DOD 
officials said that the U.S. and Palau governments had agreed to hold 
the meetings annually, instead of semiannually as required by the 
compact and that recent meetings were held in Palau, Guam, and Hawaii. 

[52] Palau's domestic revenues include taxes, fees and charges, 
licenses, permits, and other direct revenues. In-kind foreign 
assistance, net investments--equal to the net change in the fair value 
of investments minus investment management fees--and other net 
financing are excluded due to market volatility associated with 
investment earnings and the prominent role in net financing of the 
compact-provided trust fund, which was designed to provide Palau with 
financing only until 2044. 

[53] FAA's Airport Improvement Program grant to Palau represented more 
than $9 million of this assistance in 2006; it expired in 2007. The 
Airport Improvement Program's reauthorization for 2008-2011 is 
currently pending before Congress. It contains language that would 
continue Palau's eligibility for this program. 

[54] IMF projected in 2006 the return required for the Palau trust fund 
to last until 2044 to be 10.4 percent. It assumed the disbursement is 
inflation adjusted while GAO's projection is based on the disbursement 
not being inflation adjusted. 

[55] To calculate the compounded returns, we used the annual nominal 
returns published in IBBOTSON Associates 2008 Yearbook. We rebalance 
the portfolio annually to maintain the asset allocation of 50 percent 
in U.S. large capital funds, 15 percent in U.S. small capital funds, 
and 35 percent in fixed income assets. See table 12 in appendix IV for 
the nominal and real returns of various time periods. 

[56] Without market volatility, an 8.6 percent return rate would allow 
the trust fund to grow in perpetuity, as shown in figure 6. 

[57] Compact section 215 states "the amounts stated in Sections 211(a), 
211(b), 211(c) and 212(b) shall be adjusted for each fiscal year by the 
percent which equals two-thirds of the percentage change in the United 
States Gross National Product Implicit Price Deflator, or seven 
percent, whichever is less in any one year, using the beginning of 
fiscal year 1981 as the base." The annual distributions from the trust 
fund are not subject to section 215. 

[58] We used the inflation rate projected by the Congressional Budget 
Office, which is lower than the historical inflation rate (from 1970 to 
2007). A higher inflation rate will lead to further decline in value. 

[59] See IMF, Republic of Palau: 2005 Article IV Consultation - Staff 
Report (Washington, D.C., March 2006). [hyperlink, 
http://www.imf.org/external/pubs/cat/longres.cfm?sk=19023.0] (accessed 
May 27, 2008). The IMF's analysis of Palau's fiscal sustainability 
prospects recognizes that Palau will undergo a period of adjustment 
after compact direct assistance expires at the end of 2009 while 
pursuing economic reforms they suggest for implementation over a 10-to 
15-year period. 

[60] Absent market volatility, we estimate that the trust fund will 
likely grow in perpetuity if either the fund's compounded return rate 
or the asset classes' historical compounded return rate continues. 
Nonetheless, the IMF reports that Palau should decrease its dependence 
on the trust fund for annual financing. As a small island economy, 
Palau is vulnerable to external shocks, including damaging weather- 
related events, and trust fund assets could be reserved in order to 
enhance Palau's resiliency to such challenges. 

[61] For example, a 2000 planning document prepared by the Japan 
International Cooperation Agency cites the need to reduce public sector 
employment by 40 percent between fiscal years 1999 and 2009, freeze 
public sector wages, privatize public sector enterprises, implement tax 
reform, and introduce vehicle-related taxes. Palau's Cost Reduction 
Plan of 2002 cites the need for government personnel restructuring, 
outsourcing services, and strengthening tax collection efforts. 

[62] Although many noncompliant businesses may be smaller in size, the 
30 largest taxpayers in Palau are estimated to provide 88 percent of 
tax revenues. 

[63] This settlement of $1.25 million represents the outstanding 
principal of $645,000 plus 50 percent ($606,000) of the interest due of 
$1.2 million. The settlement excludes in full the $4 million of 
assessed penalties. Payments are to be made at a rate of not less than 
$10,000 per month, with the remaining balance accruing interest at a 
rate of 9 percent. Several Palau officials indicated concern with the 
terms of this settlement because the former President of Palau served 
as a representative for the foreign-owned company. 

[64] In addition to rising wage costs, government officials expressed 
concern about the financial soundness of the Civil Service Pension 
Fund. A 2005 actuarial valuation found that assets were sufficient to 
cover only 50 percent of liabilities. As such, the fund must draw on 
its investments to meet current obligations, which expanded in the late 
1990s when state and college employees, who had not fully contributed 
to the plan, were added as beneficiaries. 

[65] Economic research on the impact of road investments suggests a 
variety of possible benefits, including reduced transport costs, 
lowered input prices, increased access to markets, new migration 
opportunities, and improved information flow. The IMF finds 
infrastructure investment to be a statistically significant factor for 
increasing tourism expenditure in island economies. Palau officials 
reported that two hotels, a supermarket, and a port are planned for 
construction around the road. Despite potential benefits, Palau 
officials also expressed concern about environmental costs, including 
the introduction of invasive species from a reduction in the tree 
canopy, increased sediment run off, and watershed management problems. 

[66] Tourist expenditure varies significantly by nationality. The ADB 
estimates the economic benefit from a U.S. tourist is about $900 per 
visit compared with about $150 per visit for a Taiwanese tourist. Many 
visitors from Taiwan travel on vouchers, where a large share of the 
money is paid to the travel agent rather than in country. 

[67] Palau's tourism, agriculture, and fisheries sector are highly 
dependent on the environment and vulnerable to climate change. About 25 
percent of Palau's landmass is less than 10 meters above sea level. El 
Niï¿½o events affect Palau significantly on a regular basis through 
decreased rainfall and increased sea water temperatures. Such events in 
1997 and 1998 reportedly destroyed one-third of Palau's coral reefs, 
millions of its unique jellyfish, and most of its taro crops. See 
Palau's First National Communication to the United National Framework 
Convention on Climate Change, 2002. 

[68] In 1997, a group of bank supervisors from advanced countries--the 
Basel Committee on Banking Supervision--issued the Core Principles for 
Effective Bank Supervision that provided best practices for financial 
regulation in developing countries. Since 1999, the IMF and World Bank 
have assessed member country compliance with the Basel principles. In 
2002, the IMF assessed Palau's financial system as noncompliant on 16 
of 25 Basel principles and reports improvements have not yet been made. 
The Financial Institutions Commission is working with the Palau 
Congress to revamp banking laws to be Basel compliant and is pursuing 
strengthened regulations. 

[69] The Pacific Savings Bank, which held 20 percent of deposits in 
Palau, went into receivership in November 2006 due to inadequate 
capital and nonperforming insider loans. The ADB and Financial 
Institutions Commission attribute the bank failure to weak bank 
regulation. Potential costs to the government include the $1.4 million 
deposit of the national government, the $2.1 million deposit of the 
Palau Public Utilities Corporation, and the $1.5 million deposit of the 
Civil Service Pension Fund. 

[70] Late payments by the government also have been a challenge for the 
Palau Public Utilities Corporation, which had a net loss of $6.6 
million in 2005 and 2006. According to government officials, other 
factors contributing to this net loss include the cost of providing 
universal service under a fixed fee structure and an inability to raise 
rates quickly when oil prices rise. 

[71] Unless otherwise noted, all years cited are fiscal years (Oct. 1- 
Sept. 30). 

[72] At the time of this report, Palau's fiscal year 2007 single audit 
report had not been submitted and was not due for submission until June 
30, 2008. 

[73] The FAC operates on behalf of the Office of Management and Budget 
(OMB) and its primary purposes are to disseminate audit information to 
federal agencies and the public, support OMB oversight and assessment 
of federal award audit requirements, assist federal cognizant and 
oversight agencies in obtaining OMB Circular No. A-133 data and 
reporting packages, and, to help auditors and auditees minimize the 
reporting burden of complying with OMB Circular No. A-133 audit 
requirements. 

[74] Compact of Free Association Act of 1985, Pub. L. No. 99-239, 99 
Stat. 1770 (1986). 

[75] Compact of Free Association with Micronesia and Marshall Island, 
Pub. L. No. 108-188, 117 Stat. 2720 (2003). 

  [76] For an in-depth discussion of the renegotiated FSM and RMI 
compacts, see GAO, Compact of Free Association: An Assessment of the 
Amended Compacts and Related Agreements, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-03-890T] (Washington, D.C.: Jun. 
18, 2003). 

[77] Annual grant funding is reduced each year in order to encourage 
budgetary self-reliance and transition the countries from receiving 
annual U.S. grant funding to receiving annual trust fund earnings. 
Additional funds were provided related to the U.S. military use of 
Kwajalein Atoll. 

[78] Palau government officials told us that there is no fixed schedule 
for disbursement and disbursement can happen throughout the year. In 
our simulation, we assume four equal quarterly disbursements at the end 
of each quarter each year. 

[79] Compact section 215 states "the amounts stated in Sections 211(a), 
211(b), 211(c) and 212(b) shall be adjusted for each fiscal year by the 
percent which equals two-thirds of the percentage change in the United 
States Gross National Product Implicit Price Deflator, or seven 
percent, whichever is less in any one year, using the beginning of 
Fiscal Year 1981 as the base." The annual distributions from the trust 
fund are not subject to section 215. 

[80] The project is currently the subject of a construction contract 
dispute and the final U.S. cost of the project cannot be determined 
until the dispute is resolved. 

[81] The compact road was designed and constructed to the same 
standards as noninterstate roads in the United States and included two 
12-foot-wide asphalt paved lanes, designed to carry 400 to 2,500 
vehicles per day, at speeds of up to 35 miles per hour, a pavement 
design life of 20 years, and a bridge design life of 100 years, 
providing they receive proper maintenance. The lower traffic volumes 
were used in the design of the road spur at the north end of the 
compact road and the highest volumes were used between the airport and 
Palau's capitol. The project also was designed and constructed to meet 
U.S. environmental laws and included the U.S. Fish and Wildlife 
Service, the National Marine Fisheries Service, and the U.S. 
Environmental Protection Agency as partners in the project. 

[82] Maintenance requirements were set out in the subsidiary 
construction projects agreement known as Agreement Regarding 
Construction Projects in Palau Concluded Pursuant to Section 212(a) of 
the Compact of Free Association. 

[83] USACE officials served as the project and program manager under an 
agreement with the Department of the Interior, in which USACE agreed to 
provide program and project management services, such as design 
management, contract procurement, and construction management. 

[84] The term "double bituminous" was not defined in the compact, 
however, USACE interpreted the term to mean a two-layer application of 
asphalt and stone chips similar to what is typically identified as 
"chip and seal" and is found on many rural roads in the United States. 

[85] Road specifications were set out in Annex A of the subsidiary 
construction projects agreement. 

[86] Pub. L. No. 104-134, 110 Stat. 1321, 1321-174 (1996). 

[87] Because the project was limited to 53 miles, the entire ring was 
not constructed by the United States and is currently being completed 
by Taiwan. 

[88] Construction required cutting and filling several million cubic 
yards of earth, building seven bridges, and installing 20 box culverts 
and 372 culverts. The construction employed over 1,100 workers 
representing 10 different nationalities and required more than 500 
pieces of heavy equipment at the peak of construction. 

[89] Cut slope failures on the compact road are landslides that 
resulted directly from road construction activities that cut into 
hillsides. 

[90] Expenses and budget data reported for the compact road are based 
on information received in interviews and have not been independently 
verified. 

[91] Reported by USACE officials as of December 31, 2007. 

[92] Daewoo Eng'g and Constr. Co., LTD v. United States, 73 Fed.Cl. 547 
(2006) (notice of appeal filed on June 19, 2007). 

[93] Examples of such emergencies are tropical storms and vehicle 
accidents. 

[94] Crack sealing is a process of cleaning out cracks in the pavement 
and filling them with sealant to prevent water from getting under the 
pavement causing it to deteriorate. 

[95] The Palau Bureau of Public Works includes several organizational 
divisions such as the Division of Facilities and Maintenance, Division 
of Road and Equipment, and Division of Utilities. The Division of Road 
and Equipment is further divided into branches including the Bridge and 
Road Maintenance Branch, which is responsible for maintaining the 
compact road. 

[96] The decision to purchase a particular piece of equipment should 
include a justification process that considers all alternatives to 
accomplishing a task, including leasing, renting from other agencies or 
contractors, adapting an existing piece of equipment to perform the 
needed task, or contracting out the entire project. A piece of 
equipment may not be economically viable if not used sufficiently. 

[97] See Pub. L. No. 110-229, Title VIII, Sec. 808, 122 Stat. 874 (May 
8, 2008). 

[98] See H.R. 2881, 110th Cong. (2007). 

[99] 20 U.S.C. ï¿½ 1091. 

[100] While the formal title of the program is "Territories and Freely 
Associated States Education Grant," it is also known as the Freely 
Associated States Education Grant. 

[End of section] 

GAO's Mission: 

The Government Accountability Office, the audit, evaluation and 
investigative arm of Congress, exists to support Congress in meeting 
its constitutional responsibilities and to help improve the performance 
and accountability of the federal government for the American people. 
GAO examines the use of public funds; evaluates federal programs and 
policies; and provides analyses, recommendations, and other assistance 
to help Congress make informed oversight, policy, and funding 
decisions. GAO's commitment to good government is reflected in its core 
values of accountability, integrity, and reliability. 

Obtaining Copies of GAO Reports and Testimony: 

The fastest and easiest way to obtain copies of GAO documents at no 
cost is through GAO's Web site [hyperlink, http://www.gao.gov]. Each 
weekday, GAO posts newly released reports, testimony, and 
correspondence on its Web site. To have GAO e-mail you a list of newly 
posted products every afternoon, go to [hyperlink, http://www.gao.gov] 
and select "E-mail Updates." 

Order by Mail or Phone: 

The first copy of each printed report is free. Additional copies are $2 
each. A check or money order should be made out to the Superintendent 
of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or 
more copies mailed to a single address are discounted 25 percent. 
Orders should be sent to: 

U.S. Government Accountability Office: 
441 G Street NW, Room LM: 
Washington, D.C. 20548: 

To order by Phone: 
Voice: (202) 512-6000: 
TDD: (202) 512-2537: 
Fax: (202) 512-6061: 

To Report Fraud, Waste, and Abuse in Federal Programs: 

Contact: 

Web site: [hyperlink, http://www.gao.gov/fraudnet/fraudnet.htm]: 
E-mail: [email protected]: 
Automated answering system: (800) 424-5454 or (202) 512-7470: 

Congressional Relations: 

Ralph Dawn, Managing Director, [email protected]: 
(202) 512-4400: 
U.S. Government Accountability Office: 
441 G Street NW, Room 7125: 
Washington, D.C. 20548: 

Public Affairs: 

Chuck Young, Managing Director, [email protected]: 
(202) 512-4800: 
U.S. Government Accountability Office: 
441 G Street NW, Room 7149: 
Washington, D.C. 20548: 

*** End of document. ***