Compact of Free Association: Proposed U.S. Assistance to Palau through Fiscal Year 2024
Published: 2012-09-10T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Compact of Free Association between the United States and the Republic of Palau, which entered into force in 1994, provided for several types of assistance aimed at promoting Palaus self-sufficiency and economic advancement. Included were 15 years of direct assistance to the Palau government; contributions to a trust fund meant to provide Palau $15 million each year in fiscal years 2010 through 2044; construction of a road system, known as the Compact Road; and federal services such as postal, weather, and aviation. U.S. agencies also provided discretionary federal programs related to health, education, and infrastructure. In 2008, GAO projected that total assistance in fiscal years 1994 through 2009 would exceed $852 million.
In September 2010, the United States and Palau signed an agreement (the Agreement) that would, among other things, provide for additional assistance to Palau beginning in fiscal year 2011 and modify its trust fund. Currently, there are two bills pending before Congress to implement the Agreement.
In this testimony, GAO updates a November 2011 testimony on (1) the Agreements provisions for economic assistance to Palau, (2) its impact on the trust funds likelihood of sustaining scheduled payments through fiscal year 2044, (3) the projected role of U.S. assistance in Palau government revenues, and (4) the pending legislation to implement the Agreement. GAO reviewed current trust fund data and new pending legislation for this testimony.
section_title: What GAO Found
paragraphs: The Agreement would provide decreasing assistance, totaling approximately $215 million through fiscal year 2024 and includes the following:
direct economic assistance ($107.5 million) for Palau government operations;
infrastructure project grants ($40 million) to build mutually agreed projects;
infrastructure maintenance fund ($28 million) for maintaining the Compact Road, Palaus primary airport, and certain other major U.S.-funded projects;
fiscal consolidation fund ($10 million) to assist Palau in debt reduction; and
trust fund contributions ($30.25 million) in addition to the $70 million contributed under the compact
Under the Agreement, the United States would contribute to the trust fund in fiscal years 2013 through 2023, and Palau would reduce its withdrawals by $89 million in fiscal years 2010 through 2023. GAO projects that the fund would have a 90 percent likelihood of sustaining payments through fiscal year 2044 with these changes, versus 40 percent without these changes.
Estimates prepared for the Palau government project declining reliance on U.S. assistance under the Agreementfrom 28 percent of government revenue in fiscal year 2011 to 2 percent in fiscal year 2024and growing reliance on trust fund withdrawals and domestic revenues. The estimates show trust fund withdrawals rising from 5 percent to 24 percent and domestic revenues rising from 40 to 59 percent, of total government revenue. According to the estimates, U.S. assistance in fiscal years 2011 through 2024 would total $427 million, with discretionary federal programs accounting for about half of that amount.
Congress has not approved legislation to implement the Agreement as of September 2012. Pending Senate legislation would implement the Agreement and appropriate funds to do so. Pending House legislation would implement the agreement, apply an inflation adjustment to assistance payments, and shift the timing of certain assistance payments to reflect the fact that 2011 has passed.

section_title: Letter
paragraphs: I am pleased to be here today to discuss the September 2010 agreement  between the U.S. and Palau governments.
The Compact of Free Association between the Government of the United  States and the Government of the Republic of Palau, which entered into  force in 1994, provided for several types of assistance aimed at  promoting Palau’s economic advancement and eventual self-sufficiency.  In addition to establishing Palauan sovereignty and U.S.-Palau security  and defense arrangements, the compact provided economic assistance  to Palau. This assistance comprised, among other things, direct  economic assistance for 15 years to the Palau government; the  establishment of a trust fund intended to provide Palau $15 million  annually from 2010 through 2044; investments in infrastructure, including  a major road; and the provision of federal services, such as postal,  weather, and aviation. The compact also established a basis for U.S.  agencies to provide discretionary federal programs related to health,  education, and infrastructure. In June 2008, we projected that U.S.  assistance to Palau from 1995 through 2009 would exceed $852 million,  with assistance under the compact accounting for about 68 percent and  assistance through discretionary programs accounting for about 31  percent. We also reported in 2008 that the likelihood of the Palau trust  fund’s being able to sustain the planned payments through 2044 was  uncertain.
The September 2010 agreement between the U.S. and Palau  governments (the Agreement) followed a formal review of the compact’s  terms required 15 years after the compact entered into force. Provisions  of the Agreement would, among other things, extend economic  assistance to Palau beyond the original 15 years and modify trust fund  arrangements. The Agreement establishes an assistance schedule  beginning in 2011. There are currently two bills pending before the  Congress to approve and implement the Agreement. A bill now pending  before the U.S. Senate would approve the Agreement and also  appropriate funds to implement it. However, the Senate bill does not  reflect the fact that fiscal year 2011 has passed.  A bill now pending  before the House would approve the agreement, apply an inflation  adjustment to assistance payments, and shift the timing of certain  assistance payments to reflect the passage of fiscal year 2011.
The Senate Committee on Energy and National Resources held a hearing  to review the pending bill on June 16, 2011; the Subcommittee on Asia  and the Pacific of the House Committee on Foreign Affairs held a hearing  to assess the formal review and proposed Agreement on November 30,  2011  We testified at both hearings and described the terms of the  Agreement, assessed trust fund balances and disbursement plans under  various assumptions and investment returns, and examined single audit  reports and budget estimates prepared for the Palau government.
My statement today updates our November 2011 statement. In  particular, it describes (1) the extension of economic assistance to Palau  as outlined in the Agreement, (2) the impact that this assistance would  have on the Palau trust fund’s sustainability, (3) the projected role of U.S.  assistance in Palau government revenues, and (4) the pending legislation  to implement the Agreement. We used recent data from the Palau trust  fund to update its sustainability, and we reviewed the bill pending before  the House that was introduced in July 2012. In addition, since Congress  has not approved legislation implementing the agreement, we note that  the Department of the Interior has provided direct economic assistance to  Palau.  We conducted this work from August and September 2012 in  accordance with all sections of GAO’s Quality Assurance Framework that  are relevant to our objectives. The framework requires that we plan and  perform the engagement to obtain sufficient and appropriate evidence to  meet our stated objectives and to discuss any limitations in our work. We  believe that the information and data obtained, and the analysis we  conducted, provide a reasonable basis for any findings and conclusions in  this product.
subsections: section_title: Background
paragraphs: Palau consists of 8 main islands and more than 250 smaller islands, with  a total land area of roughly 190 square miles, located approximately 500  miles southeast of the Philippines. About 20,000 people live in Palau,  concentrated largely in one urban center around the city of Koror, and  more than one-quarter of the population is non-Palauan. Palau’s  economy is heavily dependent on its tourism sector and on foreign aid  from the United States, Japan, and Taiwan. Similar to many small island  economies, Palau’s public sector spending represents a significant  percentage of its gross domestic product (GDP).
U.S. relations with Palau began when American forces liberated the  islands near the end of World War II. In 1947, the United Nations  assigned the United States administering authority over the Trust  Territory of the Pacific Islands, which included what are now the  Federated States of Micronesia, the Republic of the Marshall Islands, the  Commonwealth of the Northern Mariana Islands, and Palau. Palau  adopted its own constitution in 1981. The U.S. and Palau governments  concluded a Compact of Free Association in 1986; the compact entered  into force on October 1, 1994. 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.
Key provisions of the compact and its subsidiary agreements address the  sovereignty of Palau, types and amounts of U.S. assistance, security and  defense authorities, and periodic reviews of compact terms. Table 1  summarizes key provisions of the Palau compact and related subsidiary  agreements.
In addition to the U.S. assistance provided under the compact, U.S.  agencies—the Department of Education, the Department of Health and  Human Services (HHS), and Interior, among others—provide  discretionary federal programs in Palau as authorized by U.S. legislation  and with appropriations from Congress. (See app. II for a complete listing  of these programs in Palau.)
In our 2008 report, we projected that U.S. assistance to Palau from 1995  through 2009 would exceed $852 million. Of this total, economic  assistance under the compact accounts for a projected 68 percent and  discretionary federal programs account for a projected 31 percent (see  fig. 1).
section_title: Agreement Would Extend U.S. Assistance for 15 Years, with Annual Decreases
paragraphs: The September 2010 Agreement between the U.S. and Palau  governments would extend assistance to Palau to 2024 but steadily  reduce the annual amount provided. The Agreement would also extend  the authority and framework for U.S. agencies to continue compact  federal services and discretionary federal programs.
subsections: section_title: Assistance to Palau Would Decline through 2024
paragraphs: Key provisions of the Agreement would include, among others, extending  direct economic assistance to Palau, providing infrastructure project  grants and contributions to an infrastructure maintenance fund,  establishing a fiscal consolidation fund, and making changes to the trust  fund. U.S. assistance to Palau under the Agreement would total  approximately $215 million through 2024.
Legislation implementing the Agreement was not approved by Congress  during 2011. Department of the Interior provided $13.1 million for direct  economic assistance in 2011 and again in 2012; however, funds were not  provided either year for infrastructure projects, the infrastructure  maintenance fund, or the fiscal consolidation fund.    Direct economic assistance ($107.5 million). Under the Agreement,  the U.S. government would provide direct economic assistance— budgetary support for Palau government operations and specific  needs such as administration of justice and public safety, health, and  education—amounting to $13 million in 2011 and declining to $2  million by 2023. The Agreement also calls for the U.S. and Palau  governments to establish a five-member Advisory Group to provide  annual recommendations and timelines for economic, financial, and  management reforms. The Advisory Group must report on Palau’s  progress in implementing these or other reforms, prior to annual U.S.- Palau economic consultations. These consultations are to review  Palau’s progress in achieving reforms such as improvements in  fiscal management, reducing the public sector workforce and salaries,  reducing government subsidization of utilities, and tax reform. If the  U.S. government determines that Palau has not made significant  progress in implementing meaningful reforms, direct assistance  payments may be delayed until the U.S. government determines that  Palau has made sufficient progress.
Infrastructure projects ($40 million). Under the Agreement, the U.S.  government would provide U.S. infrastructure project grants to Palau  for mutually agreed infrastructure projects—$8 million annually through  2013, $6 million in 2014, and $5 million in both 2015 and 2016. The  Agreement requires Palau to provide a detailed project budget and  certified scope of work for any projects receiving these funds.
Infrastructure maintenance fund ($28 million). Under the Agreement,  the U.S. government would make contributions to a fund to be used  for maintenance of U.S.-financed major capital improvement projects,  including the Compact Road and Airai International Airport. Through  2024, the U.S. government would contribute $2 million annually, and  the Palau government would contribute $600,000 annually to the  fund.    Fiscal consolidation fund ($10 million). Under the Agreement, the U.S.  government would provide grants of $5 million each in 2011 and  2012, respectively, to help the Palau government reduce its debts.  Unless agreed to in writing by the U.S. government, these grants  cannot be used to pay any entity owned or controlled by a member of  the government or his or her family, or any entity from which a  member of the government derives income. U.S. creditors must  receive priority, and the government of Palau must report quarterly on  the use of the grants until they are expended.    Trust fund ($30.25 million). Under the Agreement, the U.S.  government would contribute $30.25 million to the fund from 2013  through 2023. The government of Palau will reduce its previously  scheduled withdrawals from the fund by $89 million. From 2024  through 2044, Palau can withdraw up to $15 million annually, as  originally scheduled. Moneys from the trust fund account cannot be  spent on state block grants, operations of the office of the President of  Palau, the Olibiil Era Kelulau (Palau National Congress), or the Palau  Judiciary. Palau must use $15 million of the combined total of the trust  fund disbursements and direct economic assistance exclusively for  education, health, and the administration of justice and public safety.
Annual U.S. assistance to Palau under the Agreement would decline from  roughly $28 million in 2011 to $2 million in 2024. Figure 2 details the  timeline and composition of assistance outlined in the Agreement.
The Agreement would extend the authority for the provision of compact  federal services and discretionary programs in Palau.    Federal services. The Agreement would amend the compact’s  subsidiary agreements regarding federal services. Specifically, the  Agreement amends the terms of postal, weather, and aviation  services to Palau.    Federal discretionary programs. The Agreement would extend the  framework for U.S. agencies to provide discretionary federal programs  to Palau, with implementation of the programs contingent on annual  appropriations to those agencies.
section_title: Agreement’s Provisions Would Significantly Improve Prospects for Palau Trust Fund
paragraphs: The addition of $30.25 million in U.S. contributions and the delay of $89  million in Palau withdrawals through 2023, as provided by the Agreement,  would improve the fund’s prospects for sustaining scheduled payments  through 2044. At the end of June 2012, the fund had a balance of  approximately $163 million. The trust fund would need a 5.0 percent  annual return to yield the proposed withdrawals from 2011 through 2044  under the Agreement. This rate is well below the 7.9 percent return that  the fund earned from its inception to June 30, 2012. Figure 3 shows  projected trust fund balances in 2012 through 2044 under the Agreement,  with varying rates of return.
The additional contributions and reduced withdrawals scheduled in the  Agreement would also make the trust fund a more reliable source of  revenue under conditions of market volatility. With these changes, the  trust fund would have an approximately 90 percent probability of  sustaining payments through 2044. In comparison, the fund has a 40  percent probability of sustaining the $15 million annual withdrawals  scheduled under the compact through 2044.
Figure 4 compares the probability that the trust fund will sustain the  proposed withdrawals under the terms outlined in the Agreement with the  probability that the trust fund will sustain the withdrawals scheduled under  the compact.
section_title: Estimates Prepared for Palau Project Declining Reliance on U.S. Assistance under the Agreement
paragraphs: Estimates prepared for the government of Palau project that Palau’s  reliance on U.S. assistance provided under the Agreement will decline,  while its reliance on trust fund withdrawals and domestic revenue will  increase. These estimates show U.S. assistance, as provided under the  Agreement, declining from 28 percent of government revenue in 2011 to  less than 2 percent of government revenue in 2024. The estimates also  show Palau’s trust fund withdrawals growing from 5 percent of  government revenue in 2011 to 12 percent in 2024. In addition, the  estimates indicate that Palau’s domestic revenue will rise from 40 percent  of all government revenue in 2011 to 59 percent in 2024. Finally, the  estimates prepared for Palau project a relatively steady reliance on U.S.  discretionary federal programs, ranging from 12 percent of all government  revenue in 2011 to 14 percent in 2024. The estimates assume that  discretionary federal programs will grow at the rate of inflation; however,  discretionary programs are subject to annual appropriations and may not  increase over time.
Figure 5 shows the types and amounts of Palau’s estimated revenues for  2011 and 2024.
The estimates prepared for the government of Palau project that U.S.  assistance to Palau from 2011 through 2024, including discretionary  federal programs, will total approximately $427 million. The estimates  further project that discretionary programs will account for nearly half of  U.S. assistance through 2024, with assistance amounts specified in the  Agreement accounting for the other half. (See fig. 6.) In contrast, in 2008,  we estimated discretionary program funding accounted for less than one- third of total U.S. assistance to Palau from 1995 through 2009.
section_title: Pending Legislation Would Approve and Implement the Agreement
paragraphs: Legislation has been introduced in both the Senate and the House that  would approve and implement the September 2010 agreement between  the U.S. and Palau governments.
In February 2011, a bill was introduced in the Senate that would  implement the Agreement, as written. The Senate bill would authorize  and appropriate funds to Interior for specified assistance. The Senate bill  would also extend the authority, and authorize appropriations, for the  provision of compact federal services in Palau. However, the proposed  legislation does not appropriate funds for compact federal services. As of  September 2012, the Senate has not acted on this bill.
In June 2012, a bill was introduced in the House that would approve and  implement the Agreement, with some modifications. Specifically, the  pending House bill:    Shifts the timing of the provision of some specified Agreement  assistance to account for the fact that fiscal year 2011 has passed.      Extends the full faith and credit provision of the compact to the U.S.  commitments of assistance under the Agreement for direct economic  assistance, the trust fund, the infrastructure maintenance fund, the  fiscal consolidation fund, and infrastructure projects.     Applies an inflation adjustment to the Agreement assistance for direct  economic assistance and infrastructure project grants, and payments  to the trust fund, infrastructure maintenance fund, and fiscal  consolidation fund.      Extends a pledge of the full faith and credit of the United States for the  full payment of the amounts necessary to conduct the audits of the  assistance provided, as called for under the Agreement.
In addition, the Senate and House bills implementing the Agreement  would amend the sections of the Agreement that extend the authority for  the provision of compact federal services and discretionary programs in  Palau. The proposed Senate and House legislation would authorize  annual appropriations for weather and aviation services. The proposed  Senate and House legislation would extend the eligibility of the people,  government, and institutions of Palau for certain discretionary programs,  including special education and Pell grants. However, the proposed bills  differ in how they would authorize appropriations to subsidize postal  service to Palau, the Republic of the Marshall Islands, and the Federated  States of Micronesia. The Senate legislation would have authorized  appropriations of $1.5 million to Interior for 2011 through 2024, to  subsidize postal services provided by the U.S. Postal Service. The  proposed House legislation would authorize appropriations of $1.5 million  to Interior beginning in 2012 and through 2024, to subsidize postal  services. Under the proposed House bill, Interior would be authorized to  transfer these funds to the U.S. Postal Service under the condition that  domestic postage may be used for mail to these countries.
Chairman Fleming, Ranking Member Sablan, and Members of the  Subcommittee, this completes my prepared statement. I would be happy  to respond to any questions you may have at this time.
section_title: GAO Contact and Staff Acknowledgments
paragraphs: For further information about this statement, please contact David  Gootnick 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 statement.
Emil Friberg (Assistant Director), Ming Chen, David Dayton, Brian  Hackney, Reid Lowe, Grace Lui, and Valérie L. Nowak made key  contributions to this statement. Robert Alarapon, Benjamin Bolitzer,  Rhonda Horried, Farahnaaz Khakoo, Jeremy Sebest, Cynthia Taylor, and  Anu Mittal provided technical assistance.
section_title: Appendix I: U.S. Assistance to Palau Provided Under the Compact and Outlined in the Agreement
paragraphs: Table 2 shows the assistance provided to Palau under the compact from  1995 through 2009. Table 3 shows the proposed assistance to Palau for  2011 through 2024, as outlined in the Agreement.
section_title: Appendix II: U.S. Discretionary Program Funds Expended in 2009
paragraphs: Table 4 lists discretionary U.S. federal program funds expended by the  Palau national government, the Palau Community College, and the Palau  Community Action Agency, as reported in the organizations’ single audit  reports for 2009.