United States Government Accountability Office

GAO Report to Congressional Committees

COMPACT OF FREE 

ASSOCIATION 

Palau’s Use of and 

Accountability for 

U.S. Assistance and 

Prospects for 

Economic 

Self-Sufficiency 

June 2008 

 

GAO-08-732 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

June 2008

COMPACT OF FREE ASSOCIATION

Palau’s Use of and Accountability for U.S. Assistance 

and Prospects for Economic Self-Sufficiency 

Highlights of GAO-08-732, a report to 

congressional committees 

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 selfsufficiency 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. 

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 Palau’s 

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. Palau’s 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 Palau’s ability to address these 

weaknesses in a timely way. These weaknesses put at risk Palau’s 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 Palau’s compact annual reports to monitor 

Palau’s use of compact funds, DOI’s oversight was lacking in some matters. 

Palau’s prospects for economic self-sufficiency depend on four key factors: 

• Levels of continued U.S. assistance. Given the $10 million scheduled 

increase in Palau’s annual trust fund withdrawals in fiscal year 2010, the 

expiration of $13.3 million in compact direct assistance will likely reduce 

Palau’s national government revenues by less than 4 percent. However,

future levels of discretionary federal programs—estimated at $11.9 million 

in 2009—could 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. Palau’s 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 fund’s 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 Palau’s financial 

management challenges and assist

Palau in building financial 

management capacity. DOI and 

Palau agreed with GAO’s

recommendations. 

To view the full product, including the scope 

and methodology, click on GAO-08-732. 

For more information, contact David Gootnick 

at (202) 512-3149 or gootnickd@gao.gov. 
Contents 

Letter 1

Results in Brief 4 

Background 6

U.S. Assistance to Palau in 1995–2009 Is Projected at More Than 

$852 Million 15 

Palau Made Progress in Accountability but Has Limited Capacity to 

Address Internal Control Weaknesses; Interior’s Oversight Has 

Been Limited 26 

Palau’s Prospects for Economic Self-Sufficiency Depend on 

Multiple Factors 32 

Conclusions 44

Recommendation for Executive Action 45 

Agency Comments and Our Evaluation 45 

Appendix I Objectives, Scope, and Methodology 47 

Appendix II Relevancy of Amendments Made to FSM and RMI 

Compacts for Palau Compact Review 51 

Appendix III Economic Information for Palau 54 

Appendix IV Technical Notes on the Trust Fund Simulation 

Model 57 

Appendix V Compact Road 63 

Appendix VI Selected Federal Programs 76 

Appendix VII Compact Assistance Provided by the Department 

of the Interior 87 

Page i GAO-08-732 Compact of Free Association 
Appendix VIII Comments from the Department of Interior 88 

Appendix IX Comments from the Republic of Palau 89 

Appendix X GAO Contact and Staff Acknowledgments 93 

Tables 

Table 1: Key Provisions of the Palau Compact of Free Association 

and Related Subsidiary Agreements 11 

Table 2: Compact Direct Assistance Provisions and Amounts, 1995–

2009 17 

Table 3: Compact Federal Services, 1995–2009 20 

Table 4: Single Audit Act Report Submissions, 1995–2006 27 

Table 5: Financial Statement Audit Opinions for Palau, 1995–2006 28 

Table 6: Palau’s National Government Finances, 2000–2006 54 

Table 7: Economic and Fiscal Data for the Three Compact 

Countries 56

Table 8: Nominal Returns Distribution Based on Historical Data, 

1970-2007 59

Table 9: Cross-Correlation and Serial Correlation of Historical 

Annual Returns 60 

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 60 

Table 11: Trial Values of the Palau Trust Fund Balance, 2025–2044 61 

Table 12: Historical Rates of Return of a Portfolio Based on the 

Palau Trust Fund Asset Allocation (in percentage) 62 

Table 13: Discretionary Federal Program Funds Expended in Palau 

2006 84 

Table 14: Compact Assistance Provided by the Department of the 

Interior, Estimated Payments, 1995–2009 87 

Figures 

Figure 1: Location and Map of Palau 8 

Figure 2: Palau National Government Expenditures and Revenues 10 

Page ii GAO-08-732 Compact of Free Association 
Figure 3: U.S. Assistance to Palau 1995 – 2009 (projected) 16 

Figure 4: Top Five U.S. Agencies’ Expenditures in Palau, 1995 – 

2006 23

Figure 5: Palau National Government’s Potential Revenues in 2009 34 

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

Return 36

Figure 7: Probability That Palau Trust Fund Will Be Depleted Given 

Market Volatility, 2010–2044 38 

Figure 8: Compact Road at Beginning and End of Construction 63 

Figure 9: Map of Palau Roads and States 66 

Figure 10: Compact Road Construction Terrain and Cut Slope 

Failure 67

Figure 11: Compact Road Project Timeline 69 

Figure 12: Grass-Cutting Crews and Damaged Guardrail 72 

Page iii GAO-08-732 Compact of Free Association
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 

This is a work of the U.S. government and is not subject to copyright protection in the 

United States. The published product may be reproduced and distributed in its entirety 

without further permission from GAO. However, because this work may contain 

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necessary if you wish to reproduce this material separately. 

Page iv GAO-08-732 Compact of Free Association 
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. Fortuño 

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 1995,1

 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 

 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. 

Page 1 GAO-08-732 Compact of Free Association
discretionary federal programs.2

 The compact’s fiscal procedures 

subsidiary agreement3

 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.4

 The compact’s 

 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). 

Page 2 GAO-08-732 Compact of Free Association
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)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 

 5

The National Weather Service is part of the National Oceanic and Atmospheric 

Administration within the Department of Commerce. 

Page 3 GAO-08-732 Compact of Free Association
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. 

U.S. aid to Palau in 1995-2009—compact direct assistance,6

 compact 

federal services, compact road construction, and discretionary federal 

programs—is expected to exceed $852 million.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. 

Results in Brief 

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

 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. 

Page 4 GAO-08-732 Compact of Free Association
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.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 

 8

All trust fund return rates in this report are net of fees and commissions, unless otherwise 

stated. 

Page 5 GAO-08-732 Compact of Free Association
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. 

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 

Background 

Page 6 GAO-08-732 Compact of Free Association
Republic of the Marshall Islands (RMI), and the Republic of Palau.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.

 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. 

Page 7 GAO-08-732 Compact of Free Association
Figure 1: Location and Map of Palau 

Vietnam

Samoa

Vanuatu

Thailand

Sri Lanka

Solomon Islands

Philippines

Papua

New Guinea

Palau

Palau

Laos

South

Korea

 North

Korea

Japan

Indonesia

India

Fiji

Borneo

Taiwan

China

Burma

Australia

Equator

Republic of Marshall

Islands

Federated States of Micronesia

Northern Mariana Islands

Guam

0 15 30

miles

Source: GAO, Map Resources (map).

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 

Page 8 GAO-08-732 Compact of Free Association
capita was about $7,500.10 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).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 workers12

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.) 

 10After 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. 

11This 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 Taiwanesefunded agricultural technical mission. 

12Data on foreign workers are from Palau’s Social Security office and exclude workers not

registered with the office. 

Page 9 GAO-08-732 Compact of Free Association
Figure 2: Palau National Government Expenditures and Revenues 

Source: GAO estimates based on Palau’s single audit reports.

Wage bill

Capital

2000-2006 Average Expenditure by Type

U.S.

assistance

Taxes

Other

operating

Other donor

assistance

Dollars in

millions ($)

Percentage

of GDP (%)

Capital

Wage bill

Other

operating

Other 

domestic

39%

21%

22

22

15

40%

15%

11%

35%

39%

2000-2006 Average Revenue by Source

2006 Revenue Level

2006 Expenditure Level

Total 89.3 58

22.7

33.2

33.4

Dollars in

millions ($)

Percentage

of GDP (%)

U.S.

assistance

Other donor

assistance

Taxes

Other

domestic

8

6

19

20

Total 83.3 54

12.8

31.5

29.4

9.6

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. 

Page 10 GAO-08-732 Compact of Free Association
“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. 

Compact of Free 

Association 

The Compact of Free Association between Palau and the United States 

became effective on October 1, 1994,

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 term14 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 Description of key provisions

Title one: 

Government Relations 

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. 

 13See 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). 

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

Page 11 GAO-08-732 Compact of Free Association
Compact section Description of key provisions

Title two: 

Economic Relations 

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. 

Title three: 

Security and Defense 

Relations 

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 

agreementa

 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. 

Title four: 

General 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.

Page 12 GAO-08-732 Compact of Free Association
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. 

The compact’s fiscal procedures agreement states that the U.S. 

government has the authority and responsibility to audit all compact 

funds15 and requires Palau to submit audit reports each year on its use of 

compact funding, within the meaning of the Single Audit Act.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.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 

Other U.S. Assistance to 

Palau 

Key Compact and Related 

Agreements Accountability 

Requirements 

 15The 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. 

16All 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. 

17Office 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. 

Page 13 GAO-08-732 Compact of Free Association
to Palau’s single audits;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.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.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-togovernment relations.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.22 The U.S. government 

is required to review each plan in order to ascertain compliance and 

 18Although 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. 

19As 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. 

20Other 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. 

21According 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. 

22Palau is required to submit these economic development plans every 5 years during the

duration of title two of the compact. 

Page 14 GAO-08-732 Compact of Free Association
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.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. 

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. 

U.S. Assistance to 

Palau in 1995–2009 Is 

Projected at More 

Than $852 Million 

 23Title 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.

Page 15 GAO-08-732 Compact of Free Association
assistance for 1995-2009. U.S. agencies provide the remaining 31 percent of 

total assistance through discretionary federal programs24 (see fig. 3). 

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

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. 

Dollars in millions

Source: GAO analysis.

Compact direct assistance

($411.0)

Compact road

($149.0)

Discretionary federal programs

($266.7)

31%

48%

Compact federal services

3%

($25.3)

17%

 24Some 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. 

Page 16 GAO-08-732 Compact of Free Association
Compact direct assistance accounts for roughly half of projected U.S. 

assistance to Palau in 1995-2009, amounting to more than $411 million.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.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. 

Compact Direct Assistance 

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

Compact section Description

Amount 

provided

1995–2009 

(projected)

211(a) 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). 

$120 million

211(b) Energy production self-sufficiency 

$2 million annually for 14 years (1995-2008). 

$28 million

211(c) 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. 

$3.75 million

211(d) Maritime zone surveillance and enforcement, health programs, and postsecondary 

scholarship fund

$631,000 annually for 15 years (1995-2009). 

$9.5 million

211(e) Maritime zone surveillance and enforcement start-up activities 

One-time contribution of $666,800. 

$0.7 million

211(f) Trust fund 

$66 million in 1995 plus $4 million in 1997. 

$70 million

 25The 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. 

26Palau includes an account of its implementation of direct assistance in the compact 

annual reports it submits to the U.S. government. 

Page 17 GAO-08-732 Compact of Free Association
Compact section Description

Amount 

provided

1995–2009 

(projected)

212(b) Capital account purposes 

One-time contribution of $36 million in 1995. $36 million

213 Defense use impact fund 

One-time contribution of $5.5 million in 1995. 

$5.5 million

215 Inflation adjustment 

Yearly adjustment of amounts provided in sections 211(a), 211(b), 211(c), and 212(b). 

$98.9 million

221(b) and federal 

programs and services 

agreement 

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. 

$38.7 million

Total direct assistance $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. 

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. 

Page 18 GAO-08-732 Compact of Free Association
• The United States provided the entire $28 million of section 211(b) funds 

to Palau in 1995, when the compact went into effect,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. 

 27Although 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). 

Page 19 GAO-08-732 Compact of Free Association
• 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 215.28 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. 

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.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 

Compact Federal Services 

Federal service U.S. agency providing service 

Estimated expenditures by

U.S. agency providing 

service 1995-2009 

(projected)

Postal service U.S. Postal Service $12.3 million

Weather service National Weather Service $8.6 million

Aviation service Federal Aviation Administration $4.4 million

Total $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. 

 28Section 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. 

29These 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. 

Page 20 GAO-08-732 Compact of Free Association
USPS conveys mail30 between the United States and Palau and offers other 

services such as Priority Mail®

, cash-on-delivery, and postal money orders. 

USPS charges U.S. domestic postal rates31 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.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 Palaubound 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. 

 30Palau 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. 

31The 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. 

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

Page 21 GAO-08-732 Compact of Free Association
FAA provides aviation services33 to Palau, including en-route air traffic 

control from the mainland United States, flight inspection of airport 

navigation aids, and technical assistance and training. 

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 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.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 

Compact Road 

Discretionary Federal 

Programs 

 33FAA 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. 

34This 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. 

Page 22 GAO-08-732 Compact of Free Association
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 

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. 

Source: GAO analysis.

Dollars in millions

Other agencies

($19.8)

HHS

($51.6)

DOT

($12.9)

DOD

($23.8)

Interior

($39.1)

Education

($56.2)

10%

6%

28%

12%

19%

25%

• 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.35 These 

grants provided funding for a number of education services, including 

special and adult education programs, teacher training and curriculum 

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

Page 23 GAO-08-732 Compact of Free Association
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.36 In 

2006, 110 students participated in the Upward Bound program, which was 

worth approximately $360,000.37

• 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.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. 

 36TRIO grant-based programs are educational and opportunity outreach programs designed 

to support students from disadvantaged backgrounds. 

37The Upward Bound program, part of the TRIO programs, is designed to provide support

for participants to succeed in their precollege and higher education pursuits. 

38According 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. 

Page 24 GAO-08-732 Compact of Free Association
• 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 assistance39 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.40 The United States also has extended development loans to 

Palau.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. 

 39With 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. 

40We did not attempt to estimate the cost of Peace Corps’s presence in Palau from 1995-

2009. 

41Our 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.

Page 25 GAO-08-732 Compact of Free Association
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. 

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 in 

recent years. Although Palau submitted its single audit reports for 1998-

2004 after the established deadlines,42 Palau submitted reports for 2005 and

2006 on time.43 (See table 4.) Timely submission of single audit reports 

Palau Made Progress 

in Accountability but 

Has Limited Capacity 

to Address Internal 

Control Weaknesses; 

Interior’s Oversight 

Has Been Limited 

Palau’s Single Audits Show 

Improved Financial

Accountability but Also 

Persistent Internal Control 

Weaknesses that Palau Has 

Limited Capacity to 

Address 

Palau’s Timeliness in 

Submitting Single Audit 

Reports Has Improved

 42Under 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. 

43At 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. 

Page 26 GAO-08-732 Compact of Free Association
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 Number of months late 

1995 N/Aa

1996 N/Aa

1997 0

1998 2

1999 3

2000 29

2001 4

2002b23

2003 11

2004 6

2005 0

2006 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. 

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.44 However, for 2003-2006, Palau’s financial statements consistently 

Palau Has Improved Financial 

Statements’ Reliability but 

Lacks Capacity to Address 

Internal Control Weaknesses 

 44Auditors 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. 

Page 27 GAO-08-732 Compact of Free Association
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 Opinion on financial statements 

1995 Qualified

1996 Qualified

1997 Qualified

1998 Qualified

1999 Qualified

2000 Qualified

2001 Qualified

2002 Qualified

2003 Unqualified 

2004 Unqualified 

2005 Unqualified 

2006 Unqualified 

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

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

Despite the improved reliability of its financial statements, Palau has longstanding and significant weaknesses in its internal control over financial

reporting.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.46 These weaknesses 

 45Sound 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. 

46The 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. 

Page 28 GAO-08-732 Compact of Free Association
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. 

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.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 

Palau Has Weaknesses in Its 

Compliance with Federal 

Award Requirements and Lacks 

Capacity to Address These 

Weaknesses 

 47In 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.

Page 29 GAO-08-732 Compact of Free Association
equipment and real property management.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 1988.49

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.50 However, 

Palau’s limited staff and expertise hinder its ability to address the single 

audit report’s findings in a timely manner. 

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. 

Most Compact-related 

Reporting Requirements 

Were Met but Consultation 

Requirements Were Not, 

and Interior’s Oversight 

Was Limited 

 48Of 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.

49The 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. 

50According 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. 

Page 30 GAO-08-732 Compact of Free Association
• 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.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

 51DOD 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. 

Page 31 GAO-08-732 Compact of Free Association
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 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 

Palau’s Prospects for 

Economic SelfSufficiency Depend 

on Multiple Factors 

Page 32 GAO-08-732 Compact of Free Association
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. 

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 revenues52—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.) 

Prospects for Economic 

Self-sufficiency Depend on 

Levels of Continuing U.S. 

Assistance 

 52Palau’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. 

Page 33 GAO-08-732 Compact of Free Association
Figure 5: Palau National Government’s Potential Revenues in 2009 

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 inkind 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. 

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 

0

10

20

30

40

50

60

70

80

90

100

Compact direct assistance

Discretionary federal programs

Other donor assistance

Domestic revenue

Dollars in millions

Source: GAO analysis.

$13.3

$11.9

$17.8

$43.6

U.S. Assistance

Compact direct assistance expires at the end of 2009

Discretionary federal program annual levels based on eligibility

Page 34 GAO-08-732 Compact of Free Association
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 2008.53 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. 

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.

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

Prospects for Economic 

Self-sufficiency Depend on 

Availability and Value of 

Trust Fund Withdrawals 

 53FAA’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. 

54IMF 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. 

Page 35 GAO-08-732 Compact of Free Association
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.

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 

0

100

200

300

400

500

8.1% (rate of return needed to sustain the trust fund for 35 years)

8.6% (rate of return needed to grow the trust fund in perpetuity)

9.0% (the compound rate of return Palau trust fund earned from inception to March 2008) 

Palau Trust Fund Balance (in millions)

Source: GAO analysis.

Fiscal year

account balance: $182 million

account balance: $0

account balance: $406 million

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

2035

2036

2037

2038

2039

2040

2041

2042

2043

2044

The Palau trust fund had a

balance of $160.755 million as of 

March 2008.

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

commissions. 

However, market volatility adds uncertainty regarding the availability of 

the trust fund withdrawals. Despite its historical compounded annual 

 55To 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. 

Page 36 GAO-08-732 Compact of Free Association
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,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.) 

 56Without market volatility, an 8.6 percent return rate would allow the trust fund to grow in 

perpetuity, as shown in figure 6. 

Page 37 GAO-08-732 Compact of Free Association
Figure 7: Probability That Palau Trust Fund Will Be Depleted Given Market Volatility, 2010–2044 

0

10

20

30

40

50

Percentage

Source: GAO analysis.

Fiscal year

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

2035

2036

2037

2038

2039

2040

2041

2042

2043

2044

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. 

In addition, inflation will diminish the value of the annual trust fund 

withdrawals: because the withdrawals are not adjusted for inflation,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 2010.58

 57Compact 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. 

58We 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.

Page 38 GAO-08-732 Compact of Free Association
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.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.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.61

Prospects for Economic 

Self-Sufficiency Depend on 

Fiscal Reform 

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 

 59See IMF, Republic of Palau: 2005 Article IV Consultation – Staff Report (Washington,

D.C., March 2006). 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. 

60Absent 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.

61For 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. 

Page 39 GAO-08-732 Compact of Free Association
(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 1998-2005.62 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.

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. 

 62Although many noncompliant businesses may be smaller in size, the 30 largest taxpayers

in Palau are estimated to provide 88 percent of tax revenues. 

63This 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. 

Page 40 GAO-08-732 Compact of Free Association
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.64

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.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 

Palau’s Prospects for 

Economic Self-sufficiency 

Depend on Improved 

Business Environment for 

Private Sector Growth 

 64In 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. 

65Economic 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. 

Page 41 GAO-08-732 Compact of Free Association
opportunities for high-end tourists66 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.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,

 66Tourist 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. 

67Palau’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 Niño 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. 

Page 42 GAO-08-732 Compact of Free Association
and financial regulations remain weak.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.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 

 68In 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. 

69The 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.

Page 43 GAO-08-732 Compact of Free Association
privacy protection. Additionally, private sector representatives 

complained that the government often delays payment of vendors for 

several years.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. 

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. 

Conclusions 

 70Late 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. 

Page 44 GAO-08-732 Compact of Free Association
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. 

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

http://www.gao.gov. 

Recommendation for 

Executive Action 

Agency Comments 

and Our Evaluation 

Page 45 GAO-08-732 Compact of Free Association
If you or your staffs have questions regarding this report, please contact 

me at (202) 512-3149 or gootnickd@gao.gov. 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.

David Gootnick 

Director, International Affairs and Trade 

Page 46 GAO-08-732 Compact of Free Association
Appendix I: Objectives, Scope, and 

Methodology 

Page 47 GAO-08-732 Compact of Free Association

Appendix I: Objectives, Scope, and 

Methodology 

This report examines (1) the provision of compact and other U.S. 

assistance to Palau from 1995-2009,

1

 (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 1995-2006,2

 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

 1

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

2

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. 
Appendix I: Objectives, Scope, and 

Methodology 

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.3

 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 

 3

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. 

Page 48 GAO-08-732 Compact of Free Association
Appendix I: Objectives, Scope, and 

Methodology 

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 

Page 49 GAO-08-732 Compact of Free Association
Appendix I: Objectives, Scope, and 

Methodology 

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. 

Page 50 GAO-08-732 Compact of Free Association
Appendix II: Re

to FSM and RM

Rev

levancy of Amendments Made 

I Compacts for Palau Compact 

iew

Page 51 GAO-08-732 Compact of Free Association

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).1

 The three countries renegotiated the compact in 2003 to 

provide an additional 20 years of economic assistance and to address 

defense and immigration issues.2

 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.3

 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. 

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.4

 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 

FSM’s and RMI’s 

Renegotiated Compacts 

Continued Economic 

Assistance while 

Increasing Accountability 

Requirements 

 1

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

2

Compact of Free Association with Micronesia and Marshall Island, Pub. L. No. 108-188, 117 

Stat. 2720 (2003). 

3

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,

GAO-03-890T (Washington, D.C.: Jun. 18, 2003). 

4

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. 
Appendix II: Relevancy of Amendments Made 

to FSM and RMI Compacts for Palau Compact 

Review

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. 

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. 

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. 

Defense Issues in the 

Amended FSM and RMI 

Compacts 

Strengthened Immigration 

Provisions in the Amended 

FSM and RMI Compacts 

Page 52 GAO-08-732 Compact of Free Association
Appendix II: Relevancy of Amendments Made 

to FSM and RMI Compacts for Palau Compact 

Review

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. 

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. 

Supplemental Education 

Grant in the Amended FSM 

and RMI Compacts’ 

Implementing Legislation 

Page 53 GAO-08-732 Compact of Free Association
Appendix III: Economic Information 

for Palau 

Page 54 GAO-08-732 Compact of Free Association

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) 

 2000 2001 2002 2003 2004 2005 2006 Potential 2009b

Total revenue $57,263 $58,925 $59,432 $65,551 $68,720 $73,717 $83,324 $86,606

Domestic revenuea29,993 30,943 30,648 31,343 32,667 38,928 38,975 43,632

 Tax income 24,398 25,648 24,097 24,723 26,130 30,085 29,376 35,599

U.S. assistance 20,908 21,091 21,481 21,962 26,320 21,225 31,525 25,185

 Compact direct assistance 13,642 13,785 13,928 13,928 14,071 10,471 12,717 13,271

 Discretionary federal programsc

7,266 7,306 7,553 8,034 12,249 10,754 18,808 11,914

Other donor assistance 6,362 6,891 7,303 12,246 9,733 13,564 12,824 17,789

Total expenditure 77,609 77,432 80,867 76,840 83,057 78,086 89,342 92,655

Operating expenditured65,108 62,071 59,829 61,495 63,030 64,450 66,614 67,616

 Wages and salaries 29,990 30,573 31,405 32,759 31,910 32,309 33,242 34,580

Capital expenditures 12,501 15,361 21,038 15,345 20,027 13,636 22,728 25,039

Memo items 

Net investmentse16,863 -14,405 -3,439 18,191 10,748 18,273 9,866 —

U.S. trust fund withdrawal 0 0 5,000 5,000 5,000 5,000 5,000 5,000

Gross domestic product (GDP) 118,269 123,458 120,755 121,909 130,852 141,889 154,430

U.S. cost of compact federal services 

receivedf

1,742 1,742 1,745 1,749 1,584 1,623 1,678 1,595

Population (actual number) 18,766 19,092 19,409 19,717 20,016 20,303 20,579

(Percentage of GDP (%))

Total revenues 48% 48% 49% 54% 53% 52% 54%

Domestic revenue 25% 25% 25% 26% 25% 2%7 25%

Appendix III: Economic Information 

for Palau 
Appendix III: Economic Information 

for Palau 

 2000 2001 2002 2003 2004 2005 2006 Potential 2009b

 Tax income 21% 21% 20% 20% 20% 21% 19%

U.S. assistance 18% 17% 18% 18% 20% 15% 20%

 Compact direct assistance 12% 11% 12% 11% 11% 7% 8%

 Discretionary federal programs 6% 6% 6% 7% 9% 8% 12%

Other donor assistance 5% 6% 6% 10% 7% 10% 8%

Total expenditures 66% 63% 67% 63% 63% 55% 58%

Operating expenditure 55% 50% 50% 50% 48% 45% 43%

 Wages and salaries 25% 25% 26% 27% 24% 23% 22%

Capital expenditures 11% 12% 17% 13% 15% 10% 15%

Memo items

Net investments 14% -12% -3% 15% 8% 13% 6%

U.S. trust fund withdrawal 0% 0% 4% 4% 4% 4% 3%

U.S. cost of compact federal services 

received 

1% 1% 1% 1% 1% 1% 1%

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. 

Page 55 GAO-08-732 Compact of Free Association
Appendix III: Economic Information 

for Palau 

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

Palau FSM RMI

Economic statistics, FY 2006a 

Population 20,580 108,000 52,710

GDP per capita $7,500 $2,190 $2,730

GDP (thousands) $154,430 $236,900 $144,140

Foreign assistance (thousands)b$44,350 $85,300 $58,500

Aid per capita $2,160 $790 $1,110

International visitor arrivalsc 82,400 19,280 9,170

Remittances as a percentage of GDPc-5.5% 2.5% 0.3%

Fiscal statistics, FY 2006a 

Government tax revenue as a percentage of GDP 19% 13% 17%

Government expenditure as percentage of GDP 58% 65% 65%

Total public sector employee earnings as percentage of GDPd29% 33% 36%

Average public sector wage level ($US) $11,900 $8,850 $11,330

Average private sector wage level ($US) $6,380 $4,150 $5,070

Total U.S. assistance levels 

Total compact grant assistance provided under initial compact (billions)e$0.6 $1.5 $0.7

Total compact grant assistance provided under amended compact (billions)e— $1.6 $1.1

Total U.S. trust fund contribution (millions)f$70 $508 $271

Foreign assistance as percentage of national government revenue, 2000-2006 averageb50% 65% 64%

Average annual level of discretionary federal programs, 2002-2004 (millions) $9 $45 $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. 

Page 56 GAO-08-732 Compact of Free Association
Appendix IV: Tec

Fund S

hnical Notes on the Trust 

imulation Model 

Page 57 GAO-08-732 Compact of Free Association

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.1

 In their projections, both the 

 1

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. 
Appendix IV: Technical Notes on the Trust 

Fund Simulation Model 

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.2

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 

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.

Monte Carlo Simulation

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. 

 2

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. 

Page 58 GAO-08-732 Compact of Free Association
Appendix IV: Technical Notes on the Trust 

Fund Simulation Model 

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

Small company stocks (%) Large company stocks (%) U.S. Treasury bills (%) 

Range Probability Range Probability Range Probability

-30.9 -21.56 2.70 -26.47 -22.1 2.70 1.02 1.2 2.70

-21.56 -19.95 2.70 -22.1 -14.66 2.70 1.2 1.65 2.70

-19.95 -17.43 2.70 -14.66 -11.88 2.70 1.65 2.9 2.70

-17.43 -13.28 2.70 -11.88 -9.11 2.70 2.9 2.98 2.70

-13.28 -9.3 2.70 -9.11 -7.18 2.70 2.98 3.51 2.70

-9.3 -7.31 2.70 -7.18 -4.91 2.70 3.51 3.83 2.70

-7.31 -6.67 2.70 -4.91 -3.17 2.70 3.83 3.84 2.70

-6.67 -5.22 2.70 -3.17 1.31 2.70 3.84 3.9 2.70

-5.22 -3.59 2.70 1.31 4.01 2.70 3.9 4.39 2.70

-3.59 3.11 2.70 4.01 4.91 2.70 4.39 4.66 2.70

3.11 4.43 2.70 4.91 5.23 2.70 4.66 4.68 2.70

4.43 5.69 2.70 5.23 5.49 2.70 4.68 4.8 2.70

5.69 6.85 2.70 5.49 6.27 2.70 4.8 4.86 2.70

6.85 10.18 2.70 6.27 6.56 2.70 4.86 5.08 2.70

10.18 13.88 2.70 6.56 7.67 2.70 5.08 5.12 2.70

13.88 16.17 2.70 7.67 9.99 2.70 5.12 5.21 2.70

16.17 16.5 2.70 9.99 10.87 2.70 5.21 5.26 2.70

16.5 17.62 2.70 10.87 14.31 2.70 5.26 5.47 2.70

17.62 18.39 2.70 14.31 15.8 2.70 5.47 5.61 2.70

18.39 20.98 2.70 15.8 16.81 2.70 5.61 5.65 2.70

20.98 22.77 2.70 16.81 18.44 2.70 5.65 5.8 2.70

22.77 22.78 2.70 18.44 18.47 2.70 5.8 5.89 2.70

22.78 22.87 2.70 18.47 18.98 2.70 5.89 6.16 2.70

22.87 23.35 2.70 18.98 21.04 2.70 6.16 6.35 2.70

23.35 23.46 2.70 21.04 21.41 2.70 6.35 6.52 2.70

23.46 24.66 2.70 21.41 22.51 2.70 6.52 6.93 2.70

24.66 25.38 2.70 22.51 23.07 2.70 6.93 7.18 2.70

25.38 28.01 2.70 23.07 23.84 2.70 7.18 7.72 2.70

28.01 29.79 2.70 23.84 28.58 2.70 7.72 7.81 2.70

29.79 34.46 2.70 28.58 28.7 2.70 7.81 8 2.70

34.46 39.67 2.70 28.7 30.55 2.70 8 8.37 2.70

39.67 39.88 2.70 30.55 31.49 2.70 8.37 8.8 2.70

39.88 43.46 2.70 31.49 32.16 2.70 8.8 9.85 2.70

43.46 44.63 2.70 32.16 32.42 2.70 9.85 10.38 2.70

Page 59 GAO-08-732 Compact of Free Association
Appendix IV: Technical Notes on the Trust 

Fund Simulation Model 

Small company stocks (%) Large company stocks (%) U.S. Treasury bills (%) 

Range Probability Range Probability Range Probability

44.63 52.82 2.70 32.42 33.36 2.70 10.38 10.54 2.70

52.82 57.36 2.70 33.36 37.2 2.70 10.54 11.24 2.70

57.36 60.7 2.70 37.2 37.43 2.70 11.24 14.71 2.70

Source: GAO calculation. 

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 Large company U.S. Treasury bills

Small company 1

Large company 0.66 1 

U.S. Treasury bills -0.01 0.05 1

Serial correlation -0.003 0.03 0.81

Source: GAO calculation. 

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 

Small 

company

Large 

company U.S. Treasury bills

Compounded nominal returns 13 11 6

Standard deviation 23 17 3

Strategic asset allocation in

Palau trust funda

15 50 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. 

Page 60 GAO-08-732 Compact of Free Association
Appendix IV: Technical Notes on the Trust 

Fund Simulation Model 

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.) 

Monte Carlo Simulation 

Results 

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

(Dollars in millions)

Trial 

value 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 2041 2042 2043 2044

1 62 56 48 42 29 18 4 0 0 0 0 0 0 0 0 0 0 0 0 0

2 258 305 337 338 402 442 484 516 589 641 762 915 1,013 1,112 1,304 1,494 1,843 2,134 2,477 2,818

3 93 75 59 49 44 24 11 1 0 0 0 0 0 0 0 0 0 0 0 0

4 467 509 571 602 677 770 860 843 924 1,121 1,010 1,114 1,202 1,179 1,34 1,184 1,267 1,284 1,540 1,615

5 193 173 149 143 146 140 147 149 145 163 164 158 150 152 138 130 147 147 152 155

6 175 174 159 148 122 120 98 68 54 39 30 20 8 0 0 0 0 0 0 0

7 142 131 141 147 131 146 169 160 133 130 125 129 107 97 99 101 110 115 115 118

8 135 124 130 143 134 152 166 180 177 181 155 161 138 118 123 138 116 119 110 116

9 428 385 384 431 458 469 413 513 502 579 631 692 683 608 640 686 762 706 753 933

10 764 872 878 918 1,028 1,087 1,306 1,303 1,344 1,573 1,749 1,860 2,244 2,674 2,925 3,065 3,536 4,022 4,934 4,777

11 129 111 105 109 86 73 68 63 56 54 44 32 22 8 0 0 0 0 0 0

12 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

13 139 135 154 131 107 92 91 74 49 40 25 13 1 0 0 0 0 0 0 0

14 424 472 576 605 666 761 767 775 818 972 1,139 986 982 899 1,102 1,235 1,447 1,599 1,896 2,069

15 58 50 39 32 20 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0

16 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

17 37 19 7 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

18 80 70 66 60 48 40 23 9 0 0 0 0 0 0 0 0 0 0 0 0

19 14 2 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

20 217 188 156 150 153 127 123 112 100 79 57 50 39 21 6 0 0 0 0 0

Median 147 144 142 140 135 130 127 122 118 112 106 100 93 84 75 66 56 46 34 22

10th

percentile 

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

90th

percentile 

416 443 469 502 536 576 612 661 708 762 819 887 961 1,025 1,109 1,201 1,304 1,419 1,538 1,649

Source: GAO analysis.

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

Page 61 GAO-08-732 Compact of Free Association
Appendix IV: Technical Notes on the Trust 

Fund Simulation Model 

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) 

Historical Returns of a 

Portfolio Based on Palau 

Trust Fund Asset 

Allocation with Various 

Time Periods 

Period Nominal Returns Rate of Inflation Real Returns

1926-2007 8.08 3.05 4.86

1970-2007 9.08 4.62 4.29

1988-2007 8.88 3.04 5.80

1998-2007 5.23 2.68 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. 

Page 62 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

Page 63 GAO-08-732 Compact of Free Association

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 

Source: USACE.

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 
Appendix V: Compact Road 

million.1 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.2

After completing the compact road, the United States turned it over to 

Palau, which is responsible for operating and maintaining it.

3

 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,4

 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 

road5

 with 2-foot-wide shoulders, as originally agreed, to a 53-mile, 24-foot-

 1

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. 

2

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.

3

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. 

4

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. 

5

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. 

Page 64 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

wide paved road with 4-foot-wide shoulders.6 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.7

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).8

 The design also includes a spur at the north end of the island. 

 6

Road specifications were set out in Annex A of the subsidiary construction projects

agreement. 

7

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

8

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. 

Page 65 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

Figure 9: Map of Palau Roads and States 

Koror

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

Other roads

Compact road

Palau International Airport

Airai

Ngchesar

Ngiwal

Ngaraard

Ngardmau

Ngaremlengui

Ngatpang

Aimeliik

Melekeok

Capitol of Palau

Ngarchelong

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 

Page 66 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

difficult.9 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.10 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

 9

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. 

10Cut slope failures on the compact road are landslides that resulted directly from road 

construction activities that cut into hillsides.

Page 67 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

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. 

Compact Road Was 

Completed Late but Did 

Not Exceed USACE’s 

Original Cost Estimate 

Page 68 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

Figure 11: Compact Road Project Timeline 

1999

2000

2002

2001

2003

2004

2007

2006

2005

2008

1994

1995

1996

1997

1998

April: Start-up of project discussed between Interior and USACE 

March: Interior and USACE begin program and project management agreement negotiations

October: Interior approved program funding at $149 million

November: First road survey contract awarded

April: Congress passes law allowing for project scope change

January: First environmental consultant contract awarded

November: Road design consultant contracts awarded

August: First geotechnical

a consultant contract awarded

July: Environmental impact statement completed

August: Request for proposals for construction issued

March: Road construction contract awarded

March: Environmental Quality Protection Board earth-moving permit issued

June: Partial construction notice to proceed (mobilization)

November: Full construction notice to proceed

October: Compact-specified road completion date

December: Revised construction contract completion date

October: Original construction contract completion date

October: Formal road completion and turnover to Palau

August: End of road warranty period

October: Effective date of the compact

Source: GAO, Interior, and USACE.

September: First project cost estimate by USACE

Con

struction De

sig

n

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. 

Page 69 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

USACE officials reported that U.S. costs for the project were within 

USACE’s September 1995 estimate of $149 million.11 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.12 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.13

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.

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 

U.S. Government Provided 

Road Maintenance Training and 

Operations and Maintenance 

Plan 

 11Expenses and budget data reported for the compact road are based on information 

received in interviews and have not been independently verified. 

12Reported by USACE officials as of December 31, 2007. 

13Daewoo Eng’g and Constr. Co., LTD v. United States, 73 Fed.Cl. 547 (2006) (notice of

appeal filed on June 19, 2007). 

Page 70 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

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.14 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. 

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. 

Palau Faces Challenges in 

Managing the Compact Road’s 

Maintenance According to the 

Plan 

 14Examples of such emergencies are tropical storms and vehicle accidents.

Page 71 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

Figure 12: Grass-Cutting Crews and Damaged Guardrail 

Source: GAO.

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,15 or requiring permits for the public to 

install driveways, private signs, and other obstructions in the road right-ofway. 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. 

 15Crack 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. 

Page 72 GAO-08-732 Compact of Free Association
Appendix V: Compact 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 2008.16 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. 

Funding Challenges Limit 

Palau’s Ability to Maintain the 

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

 16The 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.

Page 73 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

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.17 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.

18

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 

 17The 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. 

18See Pub. L. No. 110-229, Title VIII, Sec. 808, 122 Stat. 874 (May 8, 2008). 

Page 74 GAO-08-732 Compact of Free Association
Appendix V: Compact Road 

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. 

Page 75 GAO-08-732 Compact of Free Association
Appendix VI: Selected Federal Programs 

Page 76 GAO-08-732 Compact of Free Association

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, § 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.1 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 

 1

See H.R. 2881, 110th Cong. (2007). 
Appendix VI: Selected Federal Programs 

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.2

 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. 

 2

20 U.S.C. § 1091. 

Page 77 GAO-08-732 Compact of Free Association
Appendix VI: Selected Federal Programs 

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, § 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. 

Page 78 GAO-08-732 Compact of Free Association
Appendix VI: Selected Federal Programs 

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, § 611, as added by Pub. L. No. 

108-446, § 101, 118 Stat. 2662 (2004) codified at 20 U.S.C. § 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. 

Page 79 GAO-08-732 Compact of Free Association
Appendix VI: Selected Federal Programs 

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, § 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 

Page 80 GAO-08-732 Compact of Free Association
Appendix VI: Selected Federal Programs 

Recipient: Government of Palau, Ministry of Education 

Purpose and legislation: The Freely Associated States Education Grant 

(FASEG)3 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, § 1121(b) and (c), as 

added by No Child Left Behind Act of 2001, Pub. L. No. 107-110, § 101, 115 

Stat. 1425, 1513 (2002) codified at 20 U.S.C. § 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. § 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. 

 3

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. 

Page 81 GAO-08-732 Compact of Free Association
Appendix VI: Selected Federal Programs 

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 fixedline coverage. 

Page 82 GAO-08-732 Compact of Free Association
Appendix VI: Selected Federal Programs 

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. 

Page 83 GAO-08-732 Compact of Free Association
Appendix VI: Selected Federal Programs 

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

U.S. Agency Federal Program 

2006 

Expenditure Palau Recipient 

DOT-FAA Airport Improvement Program $ 9,400,475 Palau National Government 

DOT-FAA Total 2006 Program Expenditures $ 9,400,475 

HHS Head Start $ 1,881,677 Palau Community Action 

Agency 

HHS Centers for Disease Control and Prevention—Investigations and 

Technical Assistance 

$ 1,484,325 Palau National Government

HHS Consolidated Health Centers $ 618,157 Palau National Government

HHS Substance Abuse and Mental Health Services—Projects of Regional 

and National Significance 

$ 309,518 Palau National Government

HHS National Bioterrorism Hospital Preparedness Program $ 301,596 Palau National Government

HHS Maternal and Child Health Federal Consolidated Programs $ 269,298 Palau National Government

HHS Epidemiologic Research Studies of Acquired Immunodeficiency 

Syndrome (AIDS) and Human Immunodeficiency Virus (HIV) 

Infection in Selected Population Groups 

$ 207,265 Palau National Government 

HHS Basic/Core Area Health and Education Center $ 198,255 Palau Community College 

HHS Maternal and Child Health Services Block Grant to the States $197,092 Palau National Government 

HHS Family Planning Services $140,969 Palau National Government 

HHS Block Grants for Prevention and Treatment of Substance Abuse $106,452 Palau National Government 

HHS Cooperative Agreements to Support Comprehensive School Health 

Programs to Prevent the Spread of HIV and Other Important Health 

Problems 

$101,734 Palau National Government

HHS Project Grants and Cooperative Agreements for Tuberculosis Control 

Program 

$99,112 Palau National Government

HHS Universal Newborn Hearing Screening $80,257 Palau National Government

HHS Immunization Grants $77,287 Palau National Government

HHS Consolidated Knowledge Development and Application Program $76,466 Palau National Government 

HHS Cooperative Agreements for State-based Diabetes Control Programs 

and Evaluation and Surveillance Systems 

$67,858 Palau National Government

HHS HIV Care Formula Grants $64,628 Palau National Government

HHS Block Grants for Community Mental Health Services $50,355 Palau National Government

HHS Preventive Health Services—Sexually Transmitted Disease Control 

Grants 

$30,737 Palau National Government

HHS Preventive Health and Health Services Block Grant $22,684 Palau National Government

HHS Human Immunodeficiency Virus (HIV)/Acquired Immunodeficiency 

Virus Syndrome (AIDS) Surveillance 

$17,790 Palau National Government

HHS Civil Rights and Privacy Rule Compliance Activities $11,004 Palau National Government

Page 84 GAO-08-732 Compact of Free Association
Appendix VI: Selected Federal Programs 

U.S. Agency Federal Program 

2006 

Expenditure Palau Recipient 

HHS Injury Prevention and Control Research and State and Community 

Based Programs 

$2,500 Palau National Government

HHS Total 2006 Program Expenditures $6,417,016 

Education Pell Grant $2,193,038 Palau Community College 

Education Special Education Grants to States $899,881 Palau National Government

Education Freely Associated States Education Grant Program $549,401 Palau National Government 

Education Upward Bound Program $359,618 Palau Community College 

Education Upward Bound Math and Science Program $207,487 Palau Community College 

Education Talent Search $203,054 Palau Community College 

Education Special Education Grants to States $184,386 Palau National Government

Education Student Support Services Program $182,819 Palau Community College 

Education Gaining Early Awareness and Readiness for Undergraduate 

Programs 

$171,833 Palau National Government

Education Vocational Education Basic Grants to States $153,304 Palau National Government

Education Teacher Quality Enhancement Grants $103,527 Palau National Government

Education Federal Work Study $90,439 Palau Community College 

Education Minority Science $87,899 Palau Community College 

Education Supplemental Educational Opportunity Grant $73,231 Palau Community College 

Education Vocational Education Occupational and Employment Information 

State Grants 

$53,241 Palau National Government

Education Adult Education State Grant Program $53,105 Palau National Government

Education Byrd Honors Scholarships $9,000 Palau National Government 

Education Total 2006 Program Expenditures $5,575,263

Interior Economic, Social, and Political Development of the Territories

a

$2,152,320 Palau National Government

Interior Total 2006 Program Expenditures $2,152,320

Labor Workforce Investment Act Dislocated Workers Program $159,027 Palau National Government 

Labor Workforce Investment Act Youth Activities $110,150 Palau National Government

Labor Workforce Investment Act Adult Program $84,400 Palau National Government

Labor Total 2006 Program Expenditures $ 353,577

Commerce Special Oceanic and Atmospheric Projects $282,528 Palau National Government

Commerce Unallied Management Projects $42,333 Palau National Government

Commerce National Oceanic and Atmospheric Administration Donation to IRC 

Meeting 

$24,300 Palau National Government

Commerce Total 2006 Program Expenditures $ 349,161

USDA Cooperative Forestry Assistance $171,757 Palau National Government

USDA Community Facilities Loans and Grants $70,619 Palau National Government 

USDA U.S. Department of Agriculture $6,610 Palau Community College 

USDA Total 2006 Program Expenditures $ 248,986 

Page 85 GAO-08-732 Compact of Free Association
Appendix VI: Selected Federal Programs 

U.S. Agency Federal Program 

2006 

Expenditure Palau Recipient 

Energy State Energy Program $ 423 Palau National Government

Energy Total 2006 Program Expenditures $423

All Agencies Total 2006 Program Expenditures $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. 

Page 86 GAO-08-732 Compact of Free Association
Appendix VII: Compact Assistance Provided by the 

Department of the Interior 

Page 87 GAO-08-732 Compact of Free Association

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

(Dollars in thousands) 

Fiscal Year 

Activity (P.L. 99-

658) 

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Totals

Sect. 211(a) Current 

Account 

12,000 12,000 12,000 12,000 7,000 7,000 7,000 7,000 7,000 7,000 6,000 6,000 6,000 6,000 6,000 120,000

Sect. 211(b) Energy 

Production 

28,000 28,000

Sect. 211(c) 

Communications 

1,650 150 150 150 150 150 150 150 150 150 150 150 150 150 150 3,750 

Sect. 211(d) 

Maritime

Surveillance, 

Health, 

Scholarships 

631 631 631 631 631 631 631 631 631 631 631 631 631 631 631 9,465

Sect. 211(e) Startup for 211(d) 667 667

Sect. 211(f) 

Investment Funda

 

66,000 4,000 70,000

Subtotal Sec. 211 108,948 12,781 16,781 12,781 7,781 7,781 7,781 7,781 7,781 7,781 6,781 6,781 6,781 6,781 6,781 231,882 

Sect. 212(b) Capital 

Account 

36,000 36,000

 Sect. 213 Defense 

Use Impact 

5,500 5,500

Sect. 215 Inflation 

Adjustment 

35,719 5,842 6,075 6,440 3,790 3,861 4,004 4,147 4,147 4,290 3,752 3,936 4,121 4,305 4,490 98,917

Subtotal 186,167 18,623 22,856 19,221 11,571 11,642 11,785 11,928 11,928 12,071 10,533 10,717 10,902 11,086 11,271 372,299

Sect. 221(b) Special 

Block Grant 

6,300 4,900 3,500 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 38,700

Direct payments 192,467 23,523 26,356 21,221 13,571 13,642 13,785 13,928 13,928 14,071 12,533 12,717 12,902 13,086 13,271 410,999

Federal servicesb 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Sect. 212(a) 

Palau Road

Construction 

53,000 96,000 149,000

Grand total, Palau 245,467 23,523 122,356 21,221 13,571 13,642 13,785 13,928 13,928 14,071 12,533 12,717 12,902 13,086 13,271 559,999

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. 
Appendix VIII: Comments from the 

Department of Interior 

Page 88 GAO-08-732 Compact of Free Association

Appendix VIII: Comments from the 

Department of Interior 
Appendix IX: Comments from the 

Republic of Palau 

Page 89 GAO-08-732 Compact of Free Association

Appendix IX: Comments from the 

Republic of Palau 
Appendix IX: Comments from the 

Republic of Palau 

Page 90 GAO-08-732 Compact of Free Association
Appendix IX: Comments from the 

Republic of Palau 

Page 91 GAO-08-732 Compact of Free Association
Appendix IX: Comments from the 

Republic of Palau 

Page 92 GAO-08-732 Compact of Free Association
Page 93 GAO-08-732 Compact of Free Association

Appendix X: GAO Contact and Staff 

Acknowledgments 

David Gootnick, 202-512-3149 or gootnickd@gao.gov

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. 

GAO Contact 

Staff 

Acknowledgements 

(320545) 
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