Compacts of Free Association: Actions Needed to Prepare for the Transition of Micronesia and the Marshall Islands to Trust Fund Income
Released: 2018-05-17T00:00:00

Letter

Background

The FSM and the RMI are independent countries located about 3,000 miles southwest of Hawaii (see fig. 1).

The FSM is a federation of four semiautonomous states—Chuuk, Kosrae, Pohnpei, and Yap—whose population and income vary widely. Chuuk, the largest state by population, has the lowest per capita gross domestic product (GDP). Overall, the FSM had a 2016 population of approximately 102,000 and a GDP per capita of about $3,200. The RMI’s 2016 population was approximately 54,000 with a GDP per capita of about $3,600. The RMI’s most recent census, in 2011, found that approximately three-quarters of the population lived in Majuro, the nation’s capital, and on the island of Ebeye in the Kwajalein Atoll. Table 1 shows the FSM’s, FSM states’, and RMI’s estimated population and annual GDP per capita in fiscal year 2016.

FSM and RMI Government Revenues

The FSM states maintain considerable authority, relative to the FSM national government, to allocate U.S. assistance and implement budgetary policies. While the United States provides compact sector grants directly to the FSM national government, a large portion of these grants is passed through and provided to the four FSM states. The states also receive other U.S. program grants that have been passed through from the national government but may also receive grants directly from U.S. agencies.

Overall, FSM public sector revenue sources include U.S. compact and program grants; grants from other countries; taxation, including taxation of foreign corporations domiciled in the FSM; and Parties to the Nauru Agreement fishing fees charged to vessels operating in its waters. In addition to maintaining departmental budgets, both the FSM national government and the FSM states have government-owned enterprises and component units, such as public utilities and port authorities, whose operations are supported by public funds. Some of these component units also receive U.S. compact sector grants or other U.S. grants passed through the FSM national or state governments or directly from U.S. agencies. According to Graduate School USA, the FSM’s public sector accounted for about 53 percent of all employment in the FSM in fiscal year 2016.

The RMI government is responsible for allocating U.S. assistance in that country, though the RMI’s 24 local governments exercise local government authority. RMI public sector revenue sources include U.S. compact and program grants, grants from other countries, ship and corporate registry earnings, and Parties to the Nauru Agreement fishing fees. The RMI government also has state-owned enterprises and component units whose operations are supported by public funds. Some of these component units receive U.S. compact sector grants or other U.S. grants passed through the RMI government or directly from U.S. agencies. According to Graduate School USA, in fiscal year 2016, RMI’s public sector accounted for approximately 48 percent of all employment in the RMI. The U.S. Army Garrison–Kwajalein Atoll, located near Ebeye island, also provides a significant source of employment for Marshallese. In September 2017, U.S. Army Garrison-Kwajalein Atoll officials estimated that approximately 1,100 Marshallese were employed at the garrison.

Compact of Free Association (1986–2003)

U.S. relations with the FSM and the RMI began during World War II, when the United States ended Japanese occupation of the region. Beginning in 1947, the United States administered the region under a United Nations trusteeship. During the 1940s and 1950s, the RMI was the site of 67 U.S. nuclear weapons tests on or near Bikini and Enewetak Atolls. The four states of the FSM voted in a 1978 referendum to become an independent nation, while the RMI established a constitutional government and declared itself a republic in 1979. Under the trusteeship agreement, both newly formed nations remained subject to the authority of the United States until 1986.

In 1986, following a period of negotiations, the United States entered into a compact of free association with the FSM and the RMI that provided for economic assistance to the two countries, secured U.S. defense rights, and allowed FSM and RMI citizens to migrate to the United States. The compact provided a framework for the United States and the two countries to work toward achieving the following three main goals: (1) establish self-government for the FSM and the RMI, (2) ensure certain national security rights for all of the parties, and (3) assist the FSM and the RMI in their efforts to advance economic development and self- sufficiency. The compact’s third goal was to be accomplished primarily through U.S. direct financial assistance to the FSM and the RMI.

Under the original compact, the FSM and the RMI used funds for general government operations; capital projects, such as building roads and investing in businesses; debt payments; and targeted sectors, such as energy and communications. The FSM concentrated much of its spending on government operations at both national and state levels, while the RMI emphasized capital spending. While the original compact set out specific obligations for reporting and consultations regarding the use of compact funds, the FSM, RMI, and U.S. governments provided little accountability over compact expenditures and did not ensure that funds were spent effectively or efficiently.

Amended Compacts of Free Association (2004– Present)

In 2003, following a period of negotiations, the United States approved separate amended compacts with the FSM and the RMI that went into effect on June 25, 2004, and May 1, 2004, respectively.

Compact Grants and Trust Fund Contributions

The amended compacts’ implementing legislation authorized and appropriated direct financial assistance to the FSM and the RMI in fiscal years 2004 through 2023, with the base amounts decreasing in most years. The annual decrements in assistance are added to the amounts deposited in the trust funds established under the amended compacts for the two nations. Earnings from the compact trust funds are intended to provide an annual source of revenue after the scheduled end of compact sector grants at the end of fiscal year 2023. Both the compact sector grants and trust fund contributions are partially adjusted for inflation each fiscal year. Appendix II provides additional information on the base and inflation-adjusted amounts of U.S. compact sector grants and trust fund contributions in fiscal years 2004 through 2023.

The amended compacts and associated fiscal procedures agreements require that compact sector grants support the countries in six core sectors—education, health, infrastructure, environment, private sector development, and public sector capacity building—with the education and health sectors having priority. These grants are described in section 211(a) of each compact and are referred to as compact sector grants or 211(a) grants. Section 211(b) of the RMI compact further states that the RMI must target a specified amount of grants to Ebeye and other Marshallese communities within Kwajalein Atoll. The RMI MUORA states that the Kwajalein-related funds provided to the RMI in the compacts shall be provided through fiscal year 2023 “and thereafter for as long as this agreement remains in effect.”

Compact Trust Fund Management and Implementation

The amended compacts and their subsidiary trust fund agreements provided that each trust fund is to be managed by a compact trust fund committee. Each compact trust fund committee includes representatives from both the United States and the respective country, but the United States is required by the terms of the trust fund agreements to hold the majority of votes on each committee. The Director of Interior’s Office of Insular Affairs serves as the chair of each committee. Trust fund committee responsibilities include overseeing fund operation, supervision, and management; investing and distributing the fund’s resources; and concluding agreements with any other contributors and other organizations. As part of this oversight, the committees are to establish an investment and distribution policy. The committees are also to determine fiscal procedures to be used in implementing the trust fund agreements based on the fiscal procedures used for compact grant administration unless otherwise agreed by the parties to the agreement.

The trust fund agreements between the United States and the FSM and the RMI allow for the agreements to be amended in writing at any time, with mutual consent of the governments. However, the U.S. legislation implementing the amended compacts requires that any amendment, change, or termination of all or any part of the compact trust fund agreements shall not enter into force until incorporated into an act of Congress.

According to the trust fund agreements, each trust fund committee is to appoint a trustee and an independent auditor. Each committee has retained an Executive Administrator to manage the daily operations of the trust fund. In addition, the committee has the authority to appoint 1 or more investment advisers and may enter into a separate agreement with 1 or more money managers. The investment policy statement for each fund guides the fund’s investment strategy and portfolio.

Compact Trust Fund Structure

The compact trust fund agreements state that no funds, other than specified trust fund administrative expenses, may be distributed from the compact trust fund prior to October 1, 2023. From fiscal year 2024 onward, the maximum allowed disbursement from each compact trust fund is the amount of the fiscal year 2023 annual grant assistance, as defined by the trust fund agreement, with full adjustment for inflation.

In addition, the trust fund committees may approve additional amounts for special needs. The RMI compact trust fund agreement excludes from the calculation of the allowed disbursement the amount of the Kwajalein- related assistance defined in section 211(b) of the RMI compact. Although the compact trust fund agreements state the maximum allowable disbursement level, they do not establish or guarantee a minimum disbursement level.

Each country’s compact trust fund consists of three interrelated accounts: the “A” account, the “B” account, and the “C” account.

The A account is the trust fund’s corpus and contains the initial, and any additional, U.S. and FSM or RMI contributions; contributions from other countries; and investment earnings. No funds, other than specified trust fund administrative expenses, may be disbursed from the A account.

The B account is the trust fund’s disbursement account and becomes active in fiscal year 2023. All income earned in 2023 will be deposited in the B account for possible disbursement in 2024. Each subsequent year’s investment income will similarly be deposited into the B account for possible disbursement the following year. If there is no investment income, no funds will be deposited in the B account for possible disbursement the following year.

The C account is the trust fund’s buffer account. Through 2022, any annual income exceeding 6 percent of the fund balance is deposited in the C account. From 2023 onward, if annual income from the A account is less than the previous year’s disbursement, adjusted for inflation, the C account may be tapped to address the shortfall. After 2023, any funds in the B account in excess of the amount approved for disbursement the following fiscal year are to be used to replenish the C account as needed, up to the maximum size of the account. The size of the C account is capped at three times the amount of the estimated annual grant assistance in 2023, including estimated inflation. If there are no funds in the C account, and no prior year investment income in the B account, no funds will be available for disbursement to the countries the following year.

Figure 2 shows the compact trust fund account structure and associated rules.

According to the U.S. trust fund agreements with the FSM and the RMI, contributions from other donors are permitted. In May 2005, Taiwan and the RMI reached an agreement that Taiwan will contribute a total of $40 million to the RMI’s compact trust fund A account between 2004 and 2023. A “D” account may also be established to hold any contributions by the FSM and the RMI governments of revenue or income from unanticipated sources. According to the trust fund agreements, the D account must be a separate account, not mixed with the rest of the trust fund. Only the RMI has a D account, governed in part by an agreement between Taiwan and the RMI.

Compact Accountability, Management Structures, and Reporting

The amended compacts’ implementing legislation and their subsidiary fiscal procedures agreements established committees to oversee compact grants to each country—the Joint Economic Management Committee (JEMCO) for the FSM and the Joint Economic Management and Financial Accountability Committee (JEMFAC) for the RMI. Each five- member committee comprises three representatives from the U.S. government and two representatives from the corresponding country, with the Director of Interior’s Office of Insular Affairs serving as the chair.

JEMCO’s and JEMFAC’s designated roles and responsibilities include the following: reviewing the budget and development plans from each of the governments; approving grant allocations and performance objectives; attaching terms and conditions to any or all annual grant awards to improve program performance and fiscal accountability; evaluating progress, management problems, and any shifts in priorities in each sector; and reviewing audits called for in the compacts.

JEMCO and JEMFAC can require that terms and conditions be attached to any and all annual compact sector grant awards to improve program performance and fiscal accountability. Under the fiscal procedures agreements governing the amended compacts, the Office of Insular Affairs is responsible for using financial reports to monitor each country’s budget and fiscal performance and for using performance reports submitted by the countries to evaluate sector grant performance. The FSM and the RMI also must adhere to specific fiscal control and accounting procedures and are required to submit annual audit reports, within the meaning of the Single Audit Act as amended.

The FSM and RMI compacts require each country to develop multiyear plans that are strategic in nature and continuously reviewed and updated through the annual budget process and that address the assistance for the defined sectors. In 2013, we recommended that Interior, as Chair of JEMCO and JEMFAC, ensure that the FSM and the RMI complete plans to address the impact of declining compact sector grants (in this report, decrement management plans). In November 2013, the FSM finalized its decrement management plan for fiscal years 2014 through 2023; the plan indicated that a similar planning process is to be repeated in 3-year intervals. In September 2014, the RMI finalized its decrement management plan for fiscal years 2015 through 2023; the plan similarly stated that a comprehensive planning process to address the ongoing decrement may proceed on a 3-year update schedule. Each decrement management plan includes commitments for budget reductions in the national governments and, in the FSM, the state governments, as well as plans to undertake actions such as tax reform.

Programs and Services Provided in Compact-Related Agreements

The amended compacts’ implementing legislation incorporates by reference related agreements extending programs and services to the FSM and RMI. The programs and services agreement with each country identifies the following programs and services as being available to each country: U.S. postal services, weather services, civil aviation, disaster preparedness and response, and telecommunications. Each programs and services agreement extends for 20 years from the compact’s entry into force. Therefore, the agreement with the FSM ends on June 24, 2024, and the agreement with the RMI ends on April 30, 2024.

Programs Authorized by U.S. Legislation

The amended compacts’ implementing legislation (Pub. L. No. 108-188) and other U.S. legislation authorize other U.S. grants, programs, and services for the FSM and RMI. Pub. L. No. 108-188 authorized an annual supplemental education grant (SEG) for the FSM and RMI in fiscal years 2005 through 2023, to be awarded in place of grants formerly awarded to the countries under several U.S. education, health, and labor programs. The FSM and RMI are not eligible for the programs replaced by the SEG during these years. Unlike the compact sector grants, the amended compacts’ implementing legislation authorized the SEG but did not appropriate funds for it. Funding for the SEG is appropriated annually to the U.S. Department of Education (Education) and transferred to Interior for disbursement. Other provisions of the amended compacts’ implementing legislation, as well as other U.S. law, make the FSM and RMI eligible for a number of additional programs. Other federal departments are responsible for the administration and oversight of their respective programs in the FSM and RMI.

The FSM and RMI Continue to Rely on U.S. Grants and Programs That End in 2023

Compact sector grants and the SEG, each of which end in 2023, continue to support a substantial portion of government expenditures in the FSM and RMI. In the FSM, compact sector grants and the SEG support about one-third of all government expenditures. The four FSM states rely on these grants to a greater extent than the FSM national government does. In the RMI, compact sector grants and the SEG support about one- quarter of all government expenditures. The end of the compacts’ programs and services agreements in 2024 would also require the FSM and RMI to bear additional costs to provide services currently provided by the United States as part of the Agreements. Appendix IV provides a detailed summary of programs and services we identified that have been provided through the amended compacts, the amended compacts’ implementing legislation, compact-related agreements, and other provisions of U.S. law, as well as their status in the FSM and RMI after 2023.

U.S. Compact Grants and Other Grants Continue to Provide Substantial Support to the FSM and RMI Budgets

U.S. Grants Scheduled to End in 2023 Support About One- Third of Total FSM Government Expenditures

The FSM national and state governments overall continue to rely on U.S. support for program expenditures. Compact sector grants, the SEG, and other U.S. grants supported almost half of FSM national and state government expenditures in fiscal year 2016. Compact sector and supplemental education grants that end in 2023 supported approximately one-third of total FSM national and state government expenditures in fiscal year 2016, while other U.S. grants supported an additional 15 percent of total FSM government expenditures (see fig. 3).

Compact sector and supplemental education grants that end in 2023 support a larger proportion of FSM state governments’ expenditures than of the FSM national government’s expenditures. In fiscal year 2016, compact sector grants and the SEG supported 8 percent of national government expenditures but supported 50 percent or more of each state’s government expenditures. Among the FSM states, Chuuk—both the largest state and the state with the lowest per capita income in the FSM—has the highest percentage of its expenditures supported by U.S. grants. (See table 2 for a summary of FSM national and state government expenditures supported by compact sector grants and the SEG, and by other U.S. grants.) Compact sector grants and the SEG support an even higher proportion of FSM states’ health and education expenditures. See app. III for a summary of the role of compact funds in the FSM health and education sectors.

The RMI continues to rely on U.S. support for program expenditures. Compact sector and supplemental education grants that end in 2023 supported approximately 25 percent of the RMI’s $123.5 million in government expenditures in fiscal year 2016, while other U.S. grants supported an additional 8 percent. Compact Kwajalein-related grants that do not end in 2023 supported an additional 3 percent (see fig. 4). Compact sector grants and the SEG support an even higher proportion of RMI health and education expenditures. See app. III for a summary of the role of compact funds in the RMI health and education sectors.

End of the Programs and Services Agreements Would Also Affect FSM and RMI Budgets

FSM and RMI budgets would be affected if the countries were to assume responsibility for providing some additional programs and services currently provided by the United States. Current U.S. law enables U.S. agencies to continue providing some programs and services now provided under the agreements after they end in 2024. However, under current law, some programs and services provided in the programs and services agreements will end and would require the FSM and RMI to bear additional costs. See appendix IV for a summary of the status of programs and services provided under the programs and services agreements after the agreements end.

Compact Trust Funds Face Continuing Risks That Trust Fund Committees Have Not Yet Addressed

Previous studies of the FSM and RMI compact trust funds, including a review we conducted in 2007, found that after fiscal year 2023 the funds are unlikely to provide maximum annual disbursements, may provide no disbursements at all in some years, and are unlikely to sustain the funds’ fiscal year 2023 value. Our updated projections for the compact trust funds show similar outlooks. Several potential strategies could improve the compact trust funds’ outlook; some of these strategies could be implemented under the current trust fund agreements, while other strategies may require changing the trust fund agreements. The compact trust fund committees have not yet prepared distribution policies, required by the trust fund agreements, that could assist the countries in planning for the transition to trust fund income. In addition, the committees have not established fiscal procedures for oversight of compact trust fund disbursements as required by the trust fund agreements. Further, the trust fund committees have not yet addressed a potential misalignment between the timing of their annual calculation of the amounts available to disburse and the FSM’s and RMI’s budget timelines, potentially complicating each country’s planning and management.

Previous Studies of Compact Trust Funds Found Increasing Risks to Disbursements and Sustainability under Current Rules

Previous studies of the compact trust funds have found that some yearly disbursements from the funds after 2023 are likely to fall short of the inflation-adjusted amount of annual grant assistance in 2023 and that the funds may provide no disbursement at all in some years. Our 2007 analysis of the compact trust funds projected a wide range of potential balances and found that the funds’ capacity to provide the maximum allowable disbursement would likely decrease over time. In addition, our analysis showed an increasing likelihood that the trust funds would exhaust the C account and be unable to provide any disbursements in the latter years of our projection. Other analyses have similarly found risks of low or zero disbursements and risks to sustainability.

Graduate School USA has prepared an annual series of economic reports on each country, including analyses of their compact trust funds.

In 2015, an Asian Development Bank report separately analyzed the trust funds.

The International Monetary Fund projected the status of the trust funds as part of its biennial FSM and RMI consultations.

Updated Projections Show Continuing Risks to Compact Trust Fund Disbursements and Sustainability

Our updated projections for the FSM and RMI compact trust funds after 2023 indicate a continued likelihood that, given their balance at the end of fiscal year 2017 and current compact trust fund rules—the baseline scenario—the funds will be unable to provide maximum disbursements (equal to the inflation- adjusted amount of annual grant assistance in 2023) in some years; unable to provide any disbursement at all in some years, with the likelihood of zero disbursement in a given year increasing over time; and unable to maintain the inflation-adjusted value of the compact trust fund after fiscal year 2023.

The compact trust funds’ C account—designed as a buffer to protect disbursements from the B account in years when the funds do not earn enough to fund the disbursement—could be exhausted by a series of years with low or negative annual returns. Since current rules do not allow disbursements from the compact trust fund corpus (the A account), exhaustion of the C account would result in zero disbursement in years when fund returns are zero or negative. Thus, there may be no funds available to disburse even if the funds’ A accounts have a balance. As a result of low or zero disbursements, the countries could face economic and fiscal shocks and significant challenges in planning programs and budgets.

FSM Compact Trust Fund Projections

Our model projects that, given the baseline scenario and a 6 percent net return, the FSM compact trust fund will experience declining disbursements relative to the maximum allowable disbursements; an increasing chance of zero disbursements; and a declining likelihood of maintaining its 2023 balance. See appendix I for a full description of our methodology and appendix V for the baseline results with alternative net returns.

Projected disbursements. We project that the FSM compact trust fund will, on average, be able to provide disbursements equal to 82 percent of the maximum allowable disbursement—the inflation- adjusted amount of 2023 annual grant assistance—in its first decade of disbursements. The likely average disbursement falls to 49 percent of the maximum in the next decade and falls further in subsequent decades. In addition, the amount available for disbursement may fluctuate substantially from year to year. Depending on the compact trust fund’s performance in the previous year, disbursements may be higher or lower than the average amount if the balance in the C account is not sufficient to provide additional disbursements.

Likelihood of providing zero disbursement. We project a 41 percent likelihood that the FSM compact trust fund will be unable to disburse any funds in 1 or more years during the first decade of trust fund disbursements. This likelihood increases over time, rising to 92 percent in fiscal years 2054 through 2063.

Likelihood of maintaining inflation-adjusted 2023 balance. We project a 13 percent likelihood that the FSM compact trust fund will maintain or exceed its inflation-adjusted fiscal year 2023 value in fiscal year 2033. This likelihood decreases in later years.

Figure 5 shows our projections of the FSM compact trust fund’s average disbursements as a percentage of maximum disbursement, the likelihood of 1 or more years of zero disbursement, and the likelihood of the fund’s maintaining its inflation-adjusted fiscal year 2023 balance given the baseline scenario and a 6 percent net return.

The FSM also maintains its own trust fund separate from the compact trust fund (see app. VI for additional information). We did not independently project the FSM Trust Fund’s future balance or potential disbursements after 2023.

RMI Compact Trust Fund Projections

Our model projects that, given the baseline scenario and a 6 percent net return, the RMI compact trust fund will experience declining disbursements relative to the maximum allowable disbursements; an increasing chance of zero disbursements; and a declining likelihood of sustaining its 2023 balance.

Projected disbursements. We project that the RMI compact trust fund will, on average, be able to provide disbursements nearly equal to the inflation-adjusted amount of 2023 annual grant assistance as defined by the trust fund agreement—the maximum allowable—in its first decade of disbursements. However, the projected disbursements as a percentage of the maximum disbursements decline by about 10 percentage points in each subsequent decade. In addition, the amount available to disburse may fluctuate substantially from year to year. Depending on the compact trust fund’s performance in the previous year, disbursements may be higher or lower than the average amount if the balance in the C account is not sufficient to provide additional disbursements.

Likelihood of providing zero disbursement. We project a 15 percent likelihood that the RMI compact trust fund will be unable to disburse any funds in 1 or more years during the first decade of trust fund disbursements. This likelihood increases over time, rising to 56 percent in fiscal years 2054 through 2063.

Likelihood of maintaining inflation-adjusted 2023 balance. We project a 41 percent likelihood that the RMI compact trust fund will maintain or exceed its inflation-adjusted fiscal year 2023 value in fiscal year 2033. This likelihood decreases in later years.

Figure 6 shows our projections of the RMI compact trust fund’s average disbursements as a percentage of maximum disbursement, its likelihood of 1 or more years of zero disbursement, and its likelihood of maintaining its inflation-adjusted fiscal year 2023 balance given the baseline scenario and a 6 percent net return.

The RMI also maintains its own D account separate from the compact trust fund (see app. VI for additional information). We did not independently project the D account balance or potential disbursements from the D account after 2023.

Reducing Disbursements, Making Additional Contributions, and Changing Disbursement Policies Would Each Affect the Outlook of the Compact Trust Funds

We conducted a series of simulations to determine the likely effects of potential strategies for improving the outlook of the FSM and RMI compact trust funds. Prior studies by Graduate School USA, the Asian Development Bank, and the International Monetary Fund examined the effects of three general approaches for improving the trust funds’ outlooks: (1) reducing planned disbursements from the funds, (2) making additional contributions to the funds, and (3) changing the compact trust fund disbursement policies. These prior studies included strategies that would require changing the trust fund agreements to permit disbursements from the A account. To isolate the impact of individual changes on compact trust fund balance and disbursements, we developed and analyzed five potential strategies based on the approaches examined in the prior studies. 1. Annual disbursements are reduced below the maximum allowable disbursement. 2. Additional annual contributions are made to the trust fund in fiscal years 2018 through 2023. 3. The trust fund agreement disbursement policies are modified to limit the annual disbursement to a fixed percentage of the fund’s moving average balance over the previous 3 years, up to the maximum disbursement amount defined by the current trust fund agreement. 4. The trust fund agreement disbursement policies are modified to reduce the amount of the annual disbursement if the compact trust fund’s moving average balance over the previous 5 years is lower than a primary target amount. 5. The trust fund agreement disbursement policies are modified to set the target disbursement as 2.1 percent of the compact trust fund’s balance in fiscal year 2024. The disbursement amount is further decreased if the fund’s moving average balance over the previous 5 years is lower than the primary target balance.

Implementing either of the first two potential strategies would not require any changes to disbursement provisions in the existing trust fund agreement, but implementing any of the remaining three strategies may require such changes. In strategies 3, 4, and 5, we analyzed strategies that would permit disbursement from the A account. Disbursing from the A account would require changing the compact trust fund agreements. The agreements can be amended in writing at any time, with mutual consent of the governments. However, the U.S. legislation implementing the amended compacts requires that any amendment, change, or termination of all or any part of the compact trust fund agreements shall not enter into force until incorporated into an act of Congress.

All of the potential strategies we analyzed would reduce or eliminate the risk of the compact trust funds experiencing years of zero disbursement. However, all of the potential strategies would require the countries to exchange a near-term reduction in resources for more predictable and sustainable disbursements in the longer term. Appendix VII presents the detailed results of our analysis.

Compact Trust Fund Committees Have Not Addressed Issues Related to Distribution Policies, Fiscal Procedures, and Disbursement Timing

Trust Fund Committees Have Not Developed Distribution Policies Required by the Compact Trust Fund Agreements

Under the compact trust fund agreements, each trust fund committee must develop a distribution policy, with the intent that compact trust fund disbursements will provide an annual source of revenue to the FSM and RMI after fiscal year 2023. The trust fund committees could use distribution policies to address risks to each fund’s sustainability. For example, the committees have the discretion to disburse an amount below the established maximum. Our analysis of potential strategies for improving the funds’ outlook shows that reducing the size of disbursements would improve each compact trust fund’s long-term sustainability. According to interviews with, and documents provided by, the trust funds’ administrator, the committees reviewed presentations in 2016, 2017, and early 2018 from the authors of previous studies and fund managers regarding the likely status of the trust funds after 2023 and have also reviewed options for addressing risks to the trust funds’ disbursements and sustainability, including changes to disbursement provisions in the compact trust fund agreements. However, as of January 2018, according to the trust funds’ administrator, neither committee had developed a distribution policy. Without a distribution policy that provides information about the size of expected disbursements, the FSM and RMI are hampered in their current and ongoing efforts to plan for the potential reduction in U.S. compact assistance after 2023.

Trust Fund Committees Have Not Established Fiscal Procedures Required by Compact Trust Fund Agreements

The compact trust fund committees have not yet established fiscal procedures for compact trust fund disbursements after fiscal year 2023. Each trust fund agreement requires the respective committee to determine the fiscal procedures to be used in implementing the trust fund agreement. The committees are to base their procedures on the compact fiscal procedures agreements, which define the membership and duties of the JEMCO and JEMFAC and single audit report requirements, among other things, unless the parties to the trust fund agreement agree to adopt different fiscal procedures. No compact trust fund disbursements are to be made unless the committee has established such trust fund fiscal procedures.

U.S., FSM, and RMI officials are aware of the need to determine the fiscal procedures that will govern oversight of compact trust fund disbursements. Issues related to future oversight of compact trust fund disbursements have been raised for discussion with U.S. representatives on JEMCO and JEMFAC. However, according to an RMI representative on the compact trust fund committee, that committee has not discussed fiscal procedures for the compact trust fund disbursements. In addition, FSM officials noted that they were unsure whether the JEMCO or the compact trust fund committees would approve specific projects. Without fiscal procedures in place, the trust fund committees will not be able to provide disbursements and the United States, the FSM, and the RMI will lack clear guidance to ensure oversight for trust fund disbursements.

Trust Fund Committees Have Not Addressed Issues Related to Disbursement Timing

The timing of the trust fund committees’ calculation of the amounts available for annual disbursement to the FSM and the RMI does not align with the countries’ budget and planning timelines. The amounts available for disbursement in a given fiscal year cannot be determined until each fund’s returns have been determined at the end of the prior year. Further, if the disbursement amounts are calculated from audited fund returns as determined by annual audits required by the trust fund agreements, the amounts may not be determined until as late as March 31, 6 months into the fiscal year for which the disbursement is to be provided. However, both the FSM and the RMI government budget cycles are completed before the annual amounts available for disbursement will be known. As a result, the FSM and RMI would have to budget without knowing the amount to be disbursed, complicating their annual budget and planning processes. See figures 7 and 8 for the FSM and RMI budget timelines for fiscal year 2024, based on their current budget calendars, relative to the dates when the compact trust fund disbursement amounts will be determined on the basis of the funds’ unaudited end-of-fiscal-year balances and of their audited balances. Standards for Internal Control in the Federal Government—which is applicable to the U.S. government but can be adopted as a best practice by nongovernmental entities—states that management should use quality information to achieve the entity’s objectives. For example, as part of using quality information, the entity obtains relevant data from reliable internal and external sources in a timely manner based on the identified information requirements.

Given the FSM’s and RMI’s current budget processes, the FSM and RMI will not have accurate and timely information on the amounts that will be available for annual disbursements for each fiscal year. The FSM Secretary of Finance and Administration, a member of the compact trust fund committee, indicated that she is aware of the discrepancy between the timing of the trust fund disbursement calculations and dates in the FSM’s budget and planning cycle and stated that the FSM would raise the issue of this discrepancy as part of its planning for the transition to relying on compact trust fund disbursements. One of the RMI’s representatives on the compact trust fund committee stated that the timing of the disbursement calculations was a challenge and would complicate RMI planning and management. Each trust fund committee received a briefing in 2016 from the trust funds’ administrator that discussed issues associated with the timing of the disbursement calculations. However, as of January 2018, the committees had not determined how they would address this issue.

FSM and RMI Decrement Plans Were Not Implemented Because of Increased Revenues, but Each Country Has Begun New Planning Efforts

The FSM and RMI did not implement planned budget reductions to address decreasing compact sector grants because of increasing revenue from other sources. FSM officials stated that they did not implement their plan’s planned budgetary reductions due to increasing revenues for the state and national governments. The RMI also did not implement budget reductions but used increased revenue, particularly from fishing fees, to offset the decrement in compact sector grants. FSM and RMI strategic plans in the key sectors of education and health focus on strategic goals and priorities rather than addressing the effect of the 2023 transition on health and education budgets. However, FSM and RMI infrastructure plans discuss funding requirements and potential alternative funding sources. The FSM, the RMI, and the United States have each established bodies to plan to address issues related to the 2023 transition to trust fund income.

Previous Decrement Management Plans Were Not Implemented Because of Growth in Revenues

FSM Long-Term Fiscal Framework

The FSM has not implemented budget reductions scheduled in its decrement management plan, the FSM-Wide Long-Term Fiscal Framework (Long-Term Fiscal Framework). The FSM’s plan included a firm commitment for a 6 percent reduction in real terms in FSM state expenditures in fiscal year 2014. Two additional 6 percent expenditure reductions were planned for fiscal years 2017 and 2020, but these were contingent reductions that would not be implemented if the FSM states received offsetting revenue to address the reductions. According to FSM national government officials, revenue increases, including growth in revenue from fishing fees, have enabled the FSM to avoid implementing the 2017 contingent 6 percent expenditure reductions, and the further reductions in fiscal year 2020 are not likely to be implemented. FSM officials cited multiple reasons for not implementing the planned reductions: Increasing revenue to the state and national governments. The FSM’s Long-Term Fiscal Framework included a plan to increase the proportion of compact sector grant funding distributed among the FSM states and reduce the proportion retained by the national government. This change in the FSM’s internal compact grant distribution formula reduced the amount of the decrement in compact sector grants received by the states that would have otherwise occurred. The FSM national government’s revenue from fishing fees has increased rapidly in recent years, allowing it to use this revenue in place of compact sector grants.

Effect of inflation adjustments on compact sector grants.

According to FSM officials, because of inflation adjustments, the nominal value of the compact sector grants has not significantly declined. As a result, the FSM government questions the need for expenditure reductions.

In addition to scheduling budget reductions, the FSM’s Long-Term Fiscal Framework included plans to implement unified tax reform measures, which also have not been implemented. However, plans to reduce the national government’s share of compact sector grants and to use surpluses to mitigate the effect of fiscal reforms were implemented. (See app. VIII for a summary of the FSM’s planned actions and their implementation.) As of January 2018, the FSM had not updated the Long- Term Fiscal Framework but had included information updates in its annual budget submittal.

RMI Decrement Management Plan

The RMI government has not implemented budget reductions scheduled in its decrement management plan. The RMI’s decrement management plan divided proposed budgetary reductions into three periods: fiscal years 2016 through 2017, fiscal years 2018 through 2020, and fiscal years 2021 through 2023. Only the reductions in the first period were to be considered binding, with adjustments in the later periods subject to review during the next 3-year planning cycle. According to RMI government officials, significant growth in fishing fee revenue and growth in ship registry and income tax revenue has minimized the initially anticipated impact of the compact decrements, thereby reducing the need to implement expenditure reductions. RMI officials noted that it expected to continue to use its own revenue in place of compact funds in fiscal years 2019 through 2023.

In addition to scheduling the budget reductions, the RMI decrement management plan includes plans to implement new taxes, program fishing fees into the annual budget, reduce subsidies to state-owned enterprises, and reduce compensation to Majuro landowners for the use of their land for utilities. The RMI has programmed a portion of its fishing fee surplus into the annual budget in each fiscal year from 2015 to 2017 but has not implemented other planned actions. (See app. VIII for a summary of planned actions and their implementation.) As of January 2018, the RMI government had not updated its plan and did not intend to do so, according to RMI officials. However, the officials stated that the government has incorporated elements of the plan, particularly its expenditure analysis, into the RMI’s medium term budget and investment framework, a planning and budgeting document submitted to JEMFAC in August 2017. In comments on a draft of this report, the RMI stated that it is developing a long-term fiscal framework in addition to the medium term budget and investment framework. According to the RMI, the long-term fiscal framework will have a 10-year outlook through 2028 and take into account compact decrements and anticipated resources from the compact trust fund and other sources.

FSM and RMI Have Developed Plans for Health, Education, and Infrastructure

FSM Sector Plans

FSM national and state infrastructure plans provide specific budgetary information to address the fiscal year 2023 transition from compact sector grants to trust fund income, such as funding requirements and sources of funding for planned infrastructure projects in fiscal years 2016 through 2025. The FSM national and state health and education plans generally focus on the national and state health and education departments’ strategic goals and priorities rather than discussing budget changes or new revenue generation strategies to address the possibility of reduced resources after 2023.

In addition to preparing sector strategic development plans, the FSM national and state governments issued the 2023 Action Plan in 2014, designed to address fiscal and economic challenges before and after compact sector grant funding ends in fiscal year 2023. In contrast to the FSM Long-Term Fiscal Framework, which committed to specific expenditure reductions and government actions prior to fiscal year 2023, the 2023 Action Plan includes an economic growth strategy that seeks to boost private sector development. The plan addresses economic growth strategies and improved performance in key economic sectors such as tourism, agriculture, and fisheries and identifies the need for the FSM national and state governments to limit expenditure growth in the medium and long terms.

RMI Sector Plans

The RMI’s infrastructure plan addresses the scheduled cessation of compact sector grant assistance in fiscal year 2023 through a review of potential future budgets, while the RMI’s education and health plans outline strategic goals and priorities. Similar to the FSM’s infrastructure plans, the RMI National Infrastructure Plan reviews budget information to address the fiscal year 2023 transition, such as planned infrastructure investments and potential alternative funding sources for fiscal years 2017 through 2026. The RMI’s national education and health plans primarily focus on goals and objectives to address key challenge areas in health and education over the next few fiscal years and do not discuss specific budget changes for the transition in 2023.

FSM, RMI, and U.S. Planning Groups Have Been Formed to Prepare for Transition to Trust Fund Income

Both the FSM and the RMI have formed planning committees and charged them with planning for the fiscal year 2023 transition from compact sector grants to compact trust fund income. In addition, the U.S. Department of State (State) has organized a U.S. interagency planning group to help coordinate U.S. policy related to the transition.

FSM Joint Compact Review and Planning Committee

In 2016, the FSM national government established a Joint Compact Review and Planning Committee to coordinate FSM planning for the transition from compact sector grants to trust fund income in 2023. The committee is mandated to, among other things, set goals in anticipation of the end of compact grants, develop strategies and alternatives, identify financial assistance sources, analyze economic information, and provide periodic reports to the FSM Congress. The committee first met in May 2017. In September 2017, the committee hired an Executive Director, who in turn hired an economist and Executive Secretary prior to the committee’s February 2018 meeting. As of January 2018, according to FSM officials, the committee had not produced any publicly available products but had collected information from various FSM government agencies.

RMI Compact Review Commission

According to the RMI Office of Compact Implementation, the RMI established the Compact Review Commission in late 2016 to plan for the fiscal year 2023 transition from compact sector grants to trust fund income. According to the Office of Compact Implementation, the commission is mandated to review the compact and make recommendations to the cabinet regarding priorities to be addressed for the fiscal year 2023 transition. Specific priorities may include the status of federal programs that will expire in fiscal year 2023, the adequacy of the compact trust fund to provide needed revenue, and other issues relevant to the cessation of compact grant assistance. In January 2018, the RMI Presidential Cabinet appointed a Compact Review Commission Coordinating Committee, consisting of the RMI Ambassador to the United States, the Director of the RMI Office of Compact Implementation, the Secretary of Finance, a private sector representative, and a legal adviser, and directed it to coordinate the commission’s meetings, actions, and reporting.

Ongoing U.S. Interagency Working Group

State began holding regular meetings of the Interagency Working Group on the Freely Associated States in February 2017 to provide guidance and oversight for policy concerning the Compacts of Free Association and to coordinate U.S. policy in light of the fiscal year 2023 transition. The group met monthly through the rest of 2017, except in November. The monthly meetings have focused individually on the FSM and RMI, as well as addressed cross-cutting issues such as donor coordination. For example, in March and July 2017, the group’s monthly meetings focused on the FSM and included participation by the U.S. Ambassador and the FSM Ambassador, respectively. Similarly, in April and June 2017, the group’s monthly meetings focused on the RMI and included participation by the U.S. and RMI ambassadors, respectively. According to State officials, the meetings will continue indefinitely on a monthly basis.

Conclusions

The U.S. compacts of free association with the FSM and the RMI provided a framework for the United States and the two countries to work toward, among other things, the goal of assisting the FSM and the RMI in their efforts to achieve economic development and self-sufficiency. The end of U.S. compact sector grants in fiscal year 2023 and the beginning of disbursements from the compact trust funds in fiscal year 2024 will mark a key transition in these ongoing efforts, and the FSM and RMI are currently preparing plans for addressing issues associated with the transition to compact trust fund income. The countries’ transition to relying on income from the compact trust funds will likely require significant budgetary choices. However, lacking the trust fund distribution policies required under the trust fund agreements, the FSM and RMI are hampered in their efforts to plan for the potential reduction in U.S. compact assistance after 2023. In addition, without the required fiscal procedures governing trust fund actions after 2023, the trust fund committees will be unable to make disbursements and the United States, the FSM, and the RMI will not have assurance of necessary oversight of trust fund disbursements. Finally, without alignment between the timing of the trust fund committees’ annual calculation of the amounts available for disbursement and the countries’ annual budget cycles, the FSM and RMI will have to plan their budgets for each fiscal year without knowing the amount of the disbursements from the compact trust funds.

Recommendations for Executive Action

We are making the following six recommendations to Interior: The Secretary of the Interior should ensure that the Director of the Office of Insular Affairs, as Chairman of the FSM compact trust fund committee, works with other members of the committee to develop a distribution policy for the FSM compact trust fund, as required by the compact trust fund agreement, that takes into account potential strategies that could address risks to the fund’s ability to provide a source of income after fiscal year 2023. (Recommendation 1)

The Secretary of the Interior should ensure that the Director of the Office of Insular Affairs, as Chairman of the FSM compact trust fund committee and of the FSM Joint Economic Management Committee, works with other members of the committees to develop the fiscal procedures required by the compact trust fund agreement. (Recommendation 2)

The Secretary of the Interior should ensure that the Director of the Office of Insular Affairs, as Chairman of the FSM compact trust fund committee, works with other members of the committee to address the timing of the calculation of compact trust fund disbursements. (Recommendation 3)

The Secretary of the Interior should ensure that the Director of the Office of Insular Affairs, as Chairman of the RMI compact trust fund committee, works with other members of the committee to develop a distribution policy for the RMI compact trust fund, as required by the compact trust fund agreement, that takes into account potential strategies that could address risks to the fund’s ability to provide a source of income after fiscal year 2023. (Recommendation 4)

The Secretary of the Interior should ensure that the Director of the Office of Insular Affairs, as Chairman of the RMI compact trust fund committee and of the RMI Joint Economic Management and Financial Accountability Committee, works with other members of the committees to develop the fiscal procedures required by the compact trust fund agreement. (Recommendation 5)

The Secretary of the Interior should ensure that the Director of the Office of Insular Affairs, as Chairman of the RMI compact trust fund committee, works with other members of the committee to address the timing of the calculation of compact trust fund disbursements. (Recommendation 6)

Agency Comments and Our Evaluation

We provided a draft of this report to the Departments of Agriculture, Commerce, Defense, Education, Energy, Health and Human Services, the Interior, Labor, State, the Treasury, and Transportation; the Federal Communications Commission; the Federal Deposit Insurance Corporation; the Federal Emergency Management Agency; the National Science Foundation; USAID; and the U.S. Postal Service, as well as to the FSM and RMI. We also provided copies of the draft to the administrator of each compact trust fund and to Graduate School USA for their technical review. The Department of the Interior, the U.S. Postal Service, and the FSM and RMI provided official comments, which are reproduced in appendixes IX through XII with, where relevant, our responses. The Departments of Agriculture, Education, Health and Human Services, Labor, State, and Transportation; the Federal Deposit Insurance Corporation; USAID; the RMI; the trust funds’ administrator, and Graduate School USA provided technical comments, which we incorporated as appropriate.

The following summarizes the official comments from Interior, the U.S. Postal Service, the FSM, and the RMI, and our responses.

Interior concurred with our recommendations and stated that discussions to address them are ongoing within the trust fund committees. In addition, Interior stated that a working group comprising staff from Interior’s Office of Insular Affairs and the Department of State’s Office of Australia, New Zealand and Pacific Island Affairs will present recommended actions related to our recommendations to the trust fund committees in 2018.

The U.S. Postal Service stated that, in general, the report includes helpful information on the compact obligations regarding postal services provided to the FSM and RMI. However, the U.S. Postal Service also provided additional information on the reimbursement shortfall for its services since 2002 in the freely associated states. The U.S. Postal Service stated that it recommends that, upon expiration of the programs and services agreements, the FSM and RMI be treated as international postal origin and destination points.

The FSM concurred with our recommendations to Interior. In addition, the FSM stated that the programs and services provided by U.S. agencies were essential to the FSM and should continue to the greatest extent possible after 2023. The FSM would like to work with U.S. officials to ensure timely approval of continuing these programs and services. The FSM also noted that we had reported the potential for the FSM compact trust fund to not provide disbursements sufficient to cover the estimated value of expiring federal services in 2002, prior to the signing of the amended compact. Further, the FSM provided additional information regarding its Long-Term Fiscal Framework and summarized ongoing public sector and tax reform efforts and its own contributions to the FSM Trust Fund.

The RMI concurred with our recommendations to Interior and provided additional comments regarding the recommendations. The RMI asserted that, absent accountability issues, the maximum annual disbursement amount should be disbursed from the compact trust fund. However, as our report notes, the compact trust fund agreements state the maximum allowable disbursement level and do not establish or guarantee a minimum disbursement level. The RMI also stated that it would prefer that future accountability procedures be based on a new agreement rather than a reshaping of the current fiscal procedures agreement. In addition, the RMI raised the issue of compensation under the tax and trade provision of the original compact as well as the effect of delays in investing the RMI compact trust fund on its current value. We discuss the tax and trade provisions in Appendix VII of our report. The RMI also recommended that amendments to the trust fund agreement should not require action by the U.S. Congress. As our report notes, the U.S. legislation implementing the amended compacts requires that any amendment, change, or termination of all or any part of the compact trust fund agreements shall not enter into force until incorporated into an act of Congress. Finally, the RMI noted that programs and services provided through the amended compacts' implementing legislation (Pub. L. No. 108-188) and the compact programs and services agreement were essential and that the RMI could not replace them by using its own resources.

We are sending copies of this report to the appropriate congressional committees and to the Departments of Agriculture, Commerce, Defense, Education, Energy, Health and Human Services, the Interior, Labor, State, the Treasury, and Transportation; the Federal Communications Commission; the Federal Deposit Insurance Corporation; the Federal Emergency Management Agency; the National Science Foundation; USAID; and the U.S. Postal Service, as well as the President of the FSM and the President of the RMI. In addition, the report will be available at no charge on GAO’s website at http://www.gao.gov.

If you or your staff have questions about 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 XIII.

Appendix I: Objectives, Scope, and Methodology

We were asked to review issues related to the Federated States of Micronesia’s (FSM) and Republic of the Marshall Islands (RMI) transition from compact grant assistance to relying on income from the compact trust funds. This report examines (1) the use and role of federal funds and programs in the FSM and RMI budgets, (2) projected compact trust fund disbursements and potential strategies to address risks to those disbursements, and (3) FSM and RMI efforts to prepare for the scheduled decrements in compact grant funding and the transition to relying on compact trust fund income.

Federal Funds and Programs

To identify the use and role of federal funds and programs, we reviewed relevant documents and interviewed knowledgeable U.S., FSM, and RMI officials during our site visits to the RMI in July 2017 and in the FSM in July and August 2017. We reviewed U.S. law; the amended compacts and associated programs and services agreements and military use and operating rights agreements with each country; each country’s government and component unit single audit reports for fiscal years 2012 through 2016; and U.S. Region IX reports for fiscal years 2015 and 2016. We analyzed expenditure and funding data in FSM and RMI single audit reports, including their Schedule of Expenditures of Federal Awards, to identify the sources of funds expended by the FSM national and state governments, the RMI national government, and their component units and calculated federal funds as a percentage of each entity’s total resources. We reviewed the single audit reports and found that the auditors did not express any qualified or adverse opinions regarding the information they used to prepare the audits’ Schedule of Expenditures of Federal Awards, which lists the amount and use of federal grants. We concluded that these data are sufficiently reliable for estimating the role of federal programs in the FSM and RMI budgets.

To identify the FSM and RMI national government component units and FSM state government component units, we reviewed the websites of, and audit reports from, the FSM Office of the National Public Auditor and the RMI Office of the Auditor-General and confirmed the list of component units we identified with FSM and RMI officials. We also discussed the uses of federal funds in the countries with FSM national and state government officials, RMI government officials, and FSM and RMI component unit representatives during our site visits to the countries. Our portrayal of the role of federal funds in the government and component unit budgets does not capture the value of any noncash goods and services that do not appear in the single audit reports. In addition, it does not capture benefits that some programs provide to individuals, such as U.S. Department of Agriculture rural housing loans and Federal Deposit Insurance Corporation insurance that benefits depositors at the Bank of the Federated States of Micronesia.

To determine the legal status of U.S. programs, services, and grants after fiscal year 2023, we analyzed the amended compacts, the compact- related agreements, and U.S. law governing the programs, services, and grants that we identified to determine whether, under current law, they would still be available to the FSM and RMI after the end of that fiscal year. For the programs and services agreement with each country, we reviewed the status of programs and services when the agreements end in fiscal year 2024. Our legal analysis included programs, services, and grants that we identified from the compacts, the amended compacts’ implementing legislation, the military use and operating rights agreements, and the programs and services agreements. We also included in our legal analysis the programs (1) that we identified through the single audit reports and Region IX reports and (2) that were not already identified through our review of the compacts, the amended compacts’ implementing legislation, and the compact-related agreements; and (3) that the single audit reports showed as having expenditures above $200,000 in any year in fiscal years 2012 through 2016 or the Region IX reports identified as providing more than $200,000 in federal funding in fiscal years 2015 or 2016. We prepared an initial list of federal programs based on our review. We then provided our list of programs to the FSM, the RMI, and the U.S. Departments of State and the Interior for their review and updated the list on the basis of information they provided.

We prepared a preliminary analysis of the post-2023 status of the programs and funding sources we identified and asked officials of the relevant U.S. agencies to review and comment on the accuracy of the list. As part of this analysis, we contacted officials from the Departments of Agriculture, Commerce, Defense, Education, Energy, Health and Human Services, the Interior, Labor, State, and Transportation; the Federal Communications Commission; the Federal Deposit Insurance Corporation; the Federal Emergency Management Agency; the National Science Foundation; the U.S. Agency for International Development; and the U.S. Postal Service. We incorporated into our analysis the comments that these officials provided, and we again asked for their review of our analysis before we completed our draft report. Our conclusions are based on a review of current law. Therefore, any changes in the applicable law subsequent to our report but before 2023 may affect the FSM’s and RMI’s eligibility for U.S. programs and funding. In addition, the availability of programs depends on appropriations made for that purpose. Although we took multiple steps to validate our list of programs with the FSM and RMI and the relevant U.S. agencies, our analysis may not have captured all U.S. grants and programs provided in the FSM and RMI.

Compact Trust Funds

To examine projected compact trust fund disbursements and actions to address risks, we reviewed previous studies of the compact trust funds; the U.S.-FSM and U.S.-RMI compact trust fund agreements; and other governance and reporting documents such as investment policy statements, presentations to the compact trust fund committees, audits, and annual reports. We also interviewed FSM and RMI officials, compact trust fund committee members, authors of the previous studies, and the funds’ administrator, investment advisers and money managers.

To project the compact trust funds’ likely income at their current value and under current trust fund rules (i.e., the baseline scenario), we built a Monte Carlo simulation model and performed 10,000 trial runs of projected returns and disbursements over a four-decade time period, using random values for key variables.

We used the following key assumptions in our compact trust fund analysis:

Compact trust fund balance. We used the unaudited FSM and RMI fiscal year 2017 year-end compact trust fund balances.

C account balance. We estimated the C account balance on the basis of the unaudited FSM and RMI fiscal year 2017 year-end balances.

To assess the reliability of the unaudited balances, we reviewed the previous years’ audits and confirmed with the trust funds’ Administrator that previous years’ audits had not resulted in any significant differences between the preliminary balances and the final audited balances. We concluded that the unaudited balances were sufficiently reliable as a basis for our projections of future trust fund performance. The March 2018 audited fund balances, released after we completed our analysis, were within $5 of the unaudited fund balances.

Amount of future compact trust fund contributions. We based the amounts of future annual U.S. contributions to both trust funds on the inflation-adjusted amounts estimated in the U.S. Department of the Interior’s (Interior) Office of Insular Affairs’ Budget Justifications and Performance Information, Fiscal Year 2018. For the RMI, we assumed that Taiwan would continue to contribute $2.4 million per year to the RMI’s A account each year through 2023 in keeping with Taiwan’s May 2005 agreement with the RMI.

Estimated annual grant assistance for fiscal year 2023. We based our estimates of fiscal year 2023 assistance on the inflation-adjusted amounts estimated by the Office of Insular Affairs. The office estimated that the FSM would receive $82 million in annual grant assistance in fiscal year 2023 and that the RMI would receive $36 million, including Kwajalein-related assistance. In keeping with the RMI compact trust fund agreement, we excluded from our analysis grants provided to the RMI under compact section 211(b) for Kwajalein-related assistance, resulting in an estimated $27 million in grant assistance to the RMI under compact section 211 in fiscal year 2023. The actual amount of annual grant assistance in fiscal year 2023 will depend on actual inflation rates in the years preceding 2023. Different assumptions about the inflation rates will result in different estimates of the amount of fiscal year 2023 annual grant assistance.

Net rate of return. In the baseline scenario, we present our results based on a 6 percent rate of return after fees are deducted. To select and assess the reasonability of this projected net rate of return, we reviewed the capital market assumptions and projections used by the money managers for the compact trust funds as well as historical market rates of return. However, because projecting the funds’ long- term performance using the current portfolio and economic assumptions has limitations, we also conducted our analyses using different nominal values for the net returns—5 percent, 7 percent, and 8 percent—in each case using a standard deviation of 13 percent. These results are presented in appendix V. We assumed a normal distribution, but we tested the same baseline analyses with a t- distribution and found that a t-distribution did not substantially affect the results.

Inflation rate after fiscal year 2023. We applied the 2 percent long- term inflation rate projected by the Congressional Budget Office.

To further analyze actions that could address risks to the compact trust funds, we modeled alternative strategies for managing the funds that were analyzed by previous studies of the compact trust funds. We identified previous studies through a literature search and by interviewing cognizant agency and trust fund officials. On the basis of this review, we developed five potential strategies that are representative of the approaches identified in previous studies. These five strategies are examples of many possible strategies, including varying amounts of disbursement reductions, additional contributions, and methods of calculating annual disbursements. We are not recommending any specific strategy. To provide additional information about potential outcomes, we also analyzed another four strategies that assumed a lower amount of additional trust fund contributions, lower disbursement reductions, or a lower percentage of the compact trust fund balance that could be withdrawn (see app. VII). To help ensure that we had appropriately reproduced the methods used in previous studies, we shared our preliminary results for strategy 4, which modeled the Moving Adjustment Rule, and strategy 5, which modeled the Sustainability Adjustment for Enhanced Reliability (SAFER), with the Graduate School USA representatives who had initially prepared these potential strategies. We analyzed each strategy separately to isolate the impact of individual changes in the strategy on compact trust fund balance and disbursements. However, in practice, these individual changes could occur in combination with each other. We again performed the Monte Carlo analysis, using the same key assumptions as in the baseline scenario, to determine the likely effects, relative to the baseline, of five potential strategies representing three approaches: (1) reducing annual compact trust fund disbursements; (2) making additional contributions; (3) and changing the disbursement policies, including strategies that would require changing the trust fund agreements to permit disbursements from the A account. We present the results of this analysis with a 6 percent net return, a standard deviation of 13 percent, and a normal distribution and tested the results with 5 percent, 7 percent, and 8 percent net returns (see app. VII for further details).

To summarize and compare our simulation results for the baseline and alternate scenarios, we analyzed the average disbursements in nominal dollars, the average disbursements in comparison with maximum disbursements, the likelihood of 1 or more years with zero disbursement, and the likelihood that the trust funds will maintain their inflation-adjusted value after fiscal year 2023.

We calculated the average disbursement in the given time periods by averaging simulated disbursements over 10-year periods (averaging first over 10 years and then over 10,000 simulated cases).

We calculated the average disbursement as a percentage of the maximum allowable disbursement by averaging the ratio of each simulated disbursement to the maximum inflation-adjusted allowable disbursement in the given period (averaging first over 10 years and then over 10,000 simulated cases).

We calculated the likelihood of zero disbursement by counting cases with 1 or more years of zero disbursement among the 10,000 simulated cases in each 10-year period.

We calculated the likelihood that the fund balance will maintain its inflation-adjusted fiscal year 2023 value by counting simulation cases where the simulated balance exceeds or equals its projected inflation- adjusted 2023 balance in the given year.

We report the disbursement results averaged by decade for the first 40 years of compact trust fund disbursements—fiscal years 2024 through 2033, fiscal years 2034 through 2043, fiscal years 2044 through 2053, and fiscal years 2054 through 2063—to summarize the overall trend in disbursements. However, depending on market volatility, disbursements during these decades are likely to fluctuate from year to year. While the projected per-decade averages can show long-term trends in the funds’ disbursements and sustainability and provide a comparison of the likely effects of the potential strategies we analyzed, the projected averages do not provide information about the volatility of changes in annual disbursement. We compare the compact trust funds’ projected value with the projected inflation-adjusted fiscal year 2023 value through 2063 in 10- year increments beginning in fiscal years 2033.

To document the status of the FSM Trust Fund and the RMI’s D account and their potential use to supplement FSM and RMI resources after 2023, we reviewed information about the FSM laws establishing the FSM Trust Fund, FSM economic reports, and the RMI-Taiwan agreement regarding the D account. We also interviewed FSM and RMI officials. We did not independently verify the FSM’s projections of the future size of, and disbursements from, its trust fund. The information on foreign law or on foreign government operations in this report is not the product of our original analysis, but is derived from interviews and secondary sources.

FSM and RMI Plans

To examine FSM and RMI efforts to prepare for the scheduled compact grant decrements, we reviewed each country’s decrement management plans to determine the FSM’s and RMI’s planned budget reductions and other actions. We then reviewed the FSM’s and RMI’s single audit reports and budget documents and interviewed FSM and RMI officials to determine whether the planned reductions had been implemented. We compared the planned actions to current legislation, single audit reports, or recent reports that discussed the status of FSM and RMI economic and financial reforms. In addition, we interviewed Interior, FSM, and RMI officials to determine whether FSM and RMI decrement management plans had been revisited or updated, why the plans were or were not adhered to, and whether the countries planned any future updates to the plans. We also conducted interviews with U.S. officials from the Department of State, a representative of Graduate School USA, and representatives of the World Bank and the International Monetary Fund regarding each country’s previous and current planning efforts.

To assess whether the FSM and RMI strategic plans for the key sectors of health, education, and infrastructure addressed the 2023 transition from compact grants and other U.S. assistance to compact trust fund income, we first obtained the relevant plans from department heads in each key sector of the FSM and RMI national governments and FSM state governments and confirmed our identification of the documents with FSM and RMI officials. We reviewed the plans to determine whether they included any discussion of budget projections, economic or financial reforms, alternative funding sources or other revenue generation strategies, and expenditure cuts or saving strategies for periods before and after fiscal year 2023. We also reviewed the FSM’s 2023 Action Plan and the RMI’s updated Medium Term Budget and Investment Framework to determine whether these documents discussed budget changes to address the 2023 transition.

Through our interviews with U.S., FSM, and RMI officials, we also learned about other ongoing planning efforts to address the 2023 transition: the U.S. Interagency Working Group on the Freely Associated States, the FSM Joint Compact Review and Planning Committee, and the RMI Compact Review Commission. Following our interviews, we reviewed and summarized documentation related to the working group’s purpose, meetings, and membership. We also contacted FSM and RMI committee members and officials to obtain additional information on the mandate, membership, and status of the FSM and RMI committees. The information contained in this report on foreign law or on foreign government operations is not the product of our original analysis, but is derived from interviews and secondary sources.

We conducted this performance audit from March 2017 to May 2018 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

Appendix II: U.S. Compact Sector Grants and Trust Fund Contributions, 2004 through 2023

The amended compacts’ implementing legislation authorized and appropriated direct financial assistance to the FSM and the RMI in fiscal years 2004 through 2023, and provided for partial inflation adjustment of the base amount of compact sector grants and trust fund contributions each year. The base amount is partially inflation-adjusted by the percentage that equals two-thirds of the percentage change in the U.S. gross domestic product implicit price deflator, or 5 percent, whichever is less in any 1 year, using the beginning of 2004 as a base. As the base amount of compact sector grants decreases, the trust fund contributions generally increase by an equivalent amount. Figure 9 shows the amount of compact sector grants and trust fund contributions each fiscal year from 2004 through 2023.

The cumulative inflation adjustment largely offsets the amount of the decrement, resulting in a relatively steady nominal amount of compact sector grants after inflation adjustments (see fig. 10). However, because the inflation adjustment is not equal to full inflation, the value of compact sector grants continues to decline in real terms.

Appendix III: Compact Grants Supporting Health and Education in the FSM and RMI

U.S. grants that end in 2023 play a significant role in the budgets of the FSM states and the RMI in the health and education sectors. The colleges of both countries have also relied on compact sector grants but rely even more on Pell grants to support their operation.

FSM states rely on U.S. grants scheduled to end in 2023 for the majority of their health and education expenditures. In fiscal year 2016, compact sector grants and the SEG supported 60 percent or more of health expenditures and 82 percent or more of state education expenditures. Table 3 shows the states’ health and education expenditures of compact sector grants and the supplemental education grant (SEG) in fiscal year 2016. In fiscal years 2012 through 2016, compact sector grants and the SEG supported 56 to 99 percent of FSM states’ health expenditures and 82 to 100 percent of FSM states’ education expenditures.

Total expenditures (dollars)

Amount (dollars)

U.S. compact sector, supplemental education, and other grants also supported approximately 76 percent of the average $21 million in annual expenditures of the College of Micronesia–FSM, an FSM government component unit, in fiscal years 2012 through 2016. Compact sector grants and the SEG, each of which end in 2023, supported approximately 15 percent of the college’s annual expenditures. Pell grants, which provide support for education expenses for qualifying students, supported more than half of the college’s annual expenditures. College officials told us that the college would be unable to operate without Pell grants. According to officials from the U.S. Department of Education, the college will remain eligible after 2023 to receive Pell grants that benefit its students as long as such grants are available to institutions and students in the United States (see app. IV).

The RMI relies on U.S. grants scheduled to end in 2023 for health and education expenditures. In fiscal year 2016, compact sector and supplemental education grants scheduled to end in 2023 supported approximately 25 percent of RMI health expenditures and approximately 59 percent of RMI education expenditures (see table 4). Kwajalein-related grants increased these percentages to 32 percent for health and 66 percent for education. In total, in fiscal years 2012 through 2016, compact sector grants and the SEG supported approximately 58 percent of RMI education expenditures and 29 percent of health expenditures. During this period, the percentage of education expenditures supported by compact sector and supplemental education grants scheduled to end in 2023 remained relatively steady and the percentage of health expenditures decreased slightly.

U.S. compact sector, supplemental education, and other grants also supported approximately half of the average $11.9 million in annual expenditures of the College of the Marshall Islands, an RMI government component unit, in fiscal years 2012 through 2016. Compact sector grants and the SEG, each of which end in 2023, supported approximately 8 percent of the college’s annual expenditures. Pell grants supported about 39 percent of the college’s expenditures. According to officials from the U.S. Department of Education, the college will remain eligible after 2023 to receive Pell grants that benefit its students, as long as such grants are available to institutions and students in the United States (see app. IV). Also in fiscal years 2012 through 2016, compact sector and supplemental education grants scheduled to end in 2023 supported about half of the expenditures of the RMI government component unit, the Marshall Islands Scholarship, Grant, and Loan Board, which provides financial assistance for educational and training opportunities. Kwajalein- related compact grants that do not end in 2023 supported an additional 13 percent of the board’s expenditures.

Appendix IV: Status of U.S. Grants and Programs in the FSM and RMI After 2023

The amended compacts, compact-related agreements, the amended compacts’ implementing legislation, and other U.S. laws provide grants or eligibility for U.S. programs and services for the FSM and RMI. The amended compacts provided compact sector, Kwajalein-related, and audit grants. Under current law, compact sector and audit grants are each scheduled to end in 2023, but the RMI military use and operating rights agreement (MUORA) extended the time frame of Kwajalein-related compact grants for as long as the agreement is in effect. The amended compacts’ implementing legislation provided additional grants, including authorizing a supplemental education grant (SEG), and identified several specific U.S. programs as available to the FSM and RMI. Under current law, the additional grants end in 2023 but the statutory authorizations for some programs identified in Pub. L. No. 108-188 provide for the continued eligibility of the FSM and RMI to receive benefits under the programs. However, after fiscal year 2023, the FSM and RMI will no longer be eligible under current U.S. law for some programs that the SEG replaced. The compact-related programs and services agreements with each country identify additional programs and services that the United States makes available to the FSM and RMI. While these agreements will end in 2024, under current law, some U.S. agencies may continue to provide programs and services similar to those provided in the agreement under other authorities. Based on the status of current law, the FSM’s and RMI’s eligibility for other programs we identified that have been provided under other current U.S. laws will not change after fiscal year 2023.

Compact Sector and Audit Grants End in 2023, but Kwajalein-Related Grants for the RMI Will Continue

Under current law, compact sector grants provided to the FSM and the RMI under their compact sections 211(a) are scheduled to end in 2023. However, the RMI is scheduled to continue to receive $7.2 million, partially inflation adjusted, related to the U.S. military base in Kwajalein Atoll and provided under section 211(b) of its compact. Under the terms of the RMI MUORA, the United States agreed to provide these Kwajalein- related grants for as long as the MUORA is in effect. The MUORA continues until 2066 and may be extended at the discretion of the United States until 2086. The amended RMI compact provides for $18 million, partially inflation adjusted, in annual payments to the RMI government to compensate for impacts from the U.S. Army Garrison–Kwajalein Atoll. These payments will continue for as long as the MUORA is in effect.

Annual compact grants of up to $500,000 (not inflation adjusted) to each country to pay for required annual audits of compact grants are scheduled to end in 2023. See table 5 for a summary of compact sector, Kwajalein- related, and audit grants.

FSM and RMI are No Longer Eligible for Many Programs Replaced by the Supplemental Education Grant

The supplemental education grant (SEG) authorized by the amended compacts’ implementing legislation is scheduled to end in fiscal year 2023 and, under current law, FSM and RMI eligibility for most programs that the SEG replaced will not resume after fiscal year 2023. Absent changes to current law, the FSM and RMI will not be eligible after fiscal year 2023 for the following programs that the SEG replaced during fiscal years 2005 through 2023: U.S. elementary and secondary education grant programs, adult education and literacy programs, career and technical education programs, job training programs, and Head Start early education programs. However, under other provisions of current law, qualifying individuals in the FSM and RMI will be eligible after fiscal year 2023 for undergraduate education grants and work-study programs that the SEG replaced. See table 6.

Some Programs and Services in the Programs and Services Agreement Will End, while Others May Continue under Other Authorities

Although the programs and services agreements with the FSM and RMI will end in fiscal year 2024, current U.S. law enables U.S. agencies to continue providing some programs and services now provided under the agreements. No current provisions of U.S. law will enable the Federal Emergency Management Agency (FEMA) to provide disaster response funding or enable the Federal Deposit Insurance Corporation to provide deposit insurance or the U.S. Postal Service to provide services to the FSM and RMI after the agreements end. However, the National Weather Service, the U.S. Department of Transportation’s (DOT) Federal Aviation Administration (FAA), and the U.S. Agency for International Development (USAID) could, under other legal authorities, provide services similar to those they now provide under the programs and services agreements.

National Weather Service. The programs and services agreements authorize the National Weather Service to fund the operations of weather stations in the FSM and RMI, which it can continue to fund after the end of the Agreements under other authorities, according to Department of Commerce officials.

Federal Aviation Administration. The programs and services agreements authorize DOT’s FAA to provide technical assistance in the FSM and RMI, which it can continue to provide after the end of the Agreements under other provisions of current U.S. law. However, DOT officials stated that FAA would require new bilateral agreements with the FSM and the RMI in order for the countries to continue to receive the civil aviation safety services that FAA currently provides under the programs and services agreements. The FAA would also seek reimbursement for any technical assistance it provides to the FSM and RMI. With regard to the civil aviation economic services of the programs and services agreements, DOT officials stated that, while the FSM and RMI could voluntarily decide to allow U.S. air carriers to continue operations in the FSM and RMI, new bilateral agreements would be needed to assure that result.

U.S. Agency for International Development. Following a U.S. presidential disaster declaration, FEMA provides the funding for disaster relief and reconstruction, which is programmed through USAID. Under current law, FEMA funds will no longer be available for this purpose once the agreements end; however, USAID will be able to provide foreign disaster assistance funding to the FSM and RMI under the same terms as it provides this assistance to other countries. After the programs and services agreements end, FEMA will be able to support disaster relief efforts only if USAID or the countries request it to do so on a reimbursable basis.

In addition, according to State and Interior officials, telecommunications- related services that the two agencies provide to the FSM and RMI under the programs and services agreements will continue as long as the FSM and RMI provide appropriate authorization for such services. Table 7 shows the status after fiscal year 2024 of programs and services currently provided to the FSM and the RMI under the agreements.

Programs Identified in the Amended Compacts’ Implementing Legislation Generally Continue after Fiscal Year 2023

Additional grants provided to the FSM and the RMI under the amended compacts’ implementing legislation will end in fiscal year 2023, but the countries’ eligibility for programs now provided under that legislation will generally continue under current U.S. law. Grants provided under the amended compacts’ implementing legislation for (1) judicial training in the FSM and the RMI, and (2) agricultural and planting programs on the RMI’s nuclear-affected Enewetak Atoll are scheduled to end. However, under current U.S. law, legal authorities permitting the operation of other programs would remain available to the FSM and RMI after fiscal year 2023. Eligibility under these legal authorities continues either because the amended compacts’ implementing legislation does not specify an ending date or because other provisions in current U.S. law make the FSM and RMI eligible for the program.

Programs provided in the amended compacts’ implementing legislation include U.S. Department of Agriculture Rural Utilities Service grant and loan programs; U.S. Department of Education Pell grants for higher education and grants under Part B of the Individuals with Disabilities Education Act for children with disabilities; programs for nuclear-affected areas in the RMI; and additional programs provided by the Departments of Commerce and Labor as well as law enforcement assistance provided by the U.S. Postal Service. See table 8 for a summary of the programs identified in the amended compacts’ implementing legislation and their status as of the end of fiscal year 2023.

Programs Identified in Other Legislation Generally Continue after Fiscal Year 2023

In addition to being eligible for the programs provided through the compact, its associated agreements, and the amended compacts’ implementing legislation, the FSM and RMI are also eligible for a number of programs under other provisions of current U.S. law. The FSM and RMI have each received funds from the U.S. Department of Agriculture for forestry and rural housing programs, multiple Health and Human Services public health program grants, Interior technical assistance and historic preservation programs, and the DOT FAA airport improvement program, among others. Under current U.S. law, the legal authorities permitting the provision of these programs in the FSM and RMI would not necessarily change after 2023. Table 9 shows the FSM’s and RMI’s eligibility for these additional grants and programs under current law after fiscal year 2023.

Appendix V: Compact Trust Fund Baseline Outcomes Calculated with Varying Return Assumptions

In order to the test the sensitivity of our compact trust fund projections to assumptions about the future rate of return, we also performed our Monte Carlo analysis using alternate rates of return. We projected the compact trust fund disbursements and balance under current compact trust fund rules on the basis of a 6 percent net return and also estimated the trust fund on the basis of 5 percent, 7 percent, and 8 percent net returns. Higher rates of return would improve the outlook for each compact trust fund. However, even with higher rates of return, our analysis shows a high likelihood that available compact trust fund disbursements will not reach an amount equivalent to maximum disbursements permitted by the compact trust fund agreement (i.e., the inflation-adjusted amount of fiscal year 2023 annual grant assistance, as defined by the trust fund agreements), a continuing risk of zero disbursements, and a decreasing likelihood that the fund will maintain or exceed its inflation-adjusted balance in fiscal year 2023. See tables 10 and 11 for our projections of FSM and RMI compact trust fund disbursements, likelihood of 1 or more years with zero disbursement, and likelihood of maintaining or exceeding its inflation-adjusted fiscal year 2023 value.

Appendix VI: FSM and RMI Country Trust Funds

The FSM and RMI each maintain their own country trust funds separate from the compact trust funds. These country trust funds are also available to provide a source of revenue after compact grants end at the end of fiscal year 2023. We did not independently project the future balance or potential disbursements from the FSM Trust Fund after 2023.

FSM Trust Fund

The FSM maintains its own trust fund, separate from the compact trust fund, which can provide additional resources after fiscal year 2023 to offset a reduction in resources relative to those made available as of fiscal year 2023. The FSM Trust Fund, established in 1999, has grown rapidly in recent years. In fiscal years 2012 through 2017, the FSM appropriated a total of $73.3 million for contributions to its trust fund. In addition, in 2015, the FSM changed its tax law to allocate 20 percent of revenue collected by the states to state subaccounts within the FSM Trust Fund. Along with investment gains, these appropriations and contributions of tax revenue have increased the FSM Trust Fund’s balance from $8 million at the end of fiscal year 2011 to $115 million as of the end of fiscal year 2017. As of 2017, the FSM proposed to continue adding $10 million annually from national government surpluses into its trust fund, with the aim of achieving a balance of $250 million by fiscal year 2023 and $10 million in annual disbursements. However, as of early 2018, according to FSM officials, the FSM planned to add $15 million per year to the FSM Trust Fund and projected that the fund would have a balance of $275 million by the end of fiscal year 2023. However, like the compact trust fund, the full balance of the FSM Trust Fund is not available for disbursement. Under current FSM law, funds in the FSM Trust Fund may not be withdrawn until fiscal year 2024. In addition, according to FSM officials, the FSM can withdraw only the fund’s earnings and cannot withdraw the inflation-adjusted value of the FSM Trust Fund corpus.

RMI D Account

The RMI also maintains its own trust fund—the compact trust fund’s D account. Although managed alongside the compact trust fund, the D account is not subject to the same disbursement provisions as the compact trust fund’s A, B, and C accounts. Instead, disbursements from the D account are subject to the provisions of the agreement between Taiwan and the RMI under which Taiwan contributed the $10 million that the RMI used to establish the D account. According to the terms of this agreement, the RMI may withdraw income after consultation with Taiwan but may not withdraw funds from the D account’s $10 million corpus. At the end of fiscal year 2017, the D account had a balance of $15.1 million, with $5.1 million potentially available for use by the RMI.

Appendix VII: Potential Trust Fund Strategies and Model Results

We conducted a series of simulations to determine the likely effects of potential strategies for improving the outlook of the FSM and RMI compact trust funds. Prior studies by Graduate School USA, the Asian Development Bank, and the International Monetary Fund examined the effects of three general approaches for improving the trust funds’ outlooks: (1) reducing planned disbursements from the funds, (2) making additional contributions to the funds, and (3) changing the compact trust fund disbursement policies. To isolate the impact of individual changes on the compact trust fund balance and disbursements, we developed and analyzed five potential strategies based on those examined in the previous studies. Reduced disbursements and additional contributions could occur without changes to the trust fund agreement, but changes to the disbursement policies may require changing the agreements. In strategies 3, 4, and, 5, we analyzed strategies that would permit disbursement from the A account. Disbursing from the A account would require changing the compact trust fund agreements. Table 12 shows the 5 potential strategies we analyzed.

We analyzed two potential strategies that could be implemented without changes to the trust fund agreements: reductions in the amount of disbursements and additional contributions to the trust funds.

Strategy 1: Annual disbursements are reduced below the maximum allowable disbursement. We analyzed the likely effects of reducing disbursements to an amount 30 percent below the maximum disbursement, relative to the baseline scenario, for both the FSM and the RMI compact trust funds.

For the FSM, the average size of the disbursements would be lower in the first 10 years of our projection, fiscal years 2024 through 2033, but greater in later years. For the RMI, the average disbursement size would remain lower than the disbursement amounts we projected using the baseline scenario. Disbursement amounts would remain volatile from year to year if the balance in the C account is not sufficient to provide additional disbursements.

For both countries, the risk of zero disbursements would be reduced, but not eliminated, in each decade.

For both countries, the likelihood that the funds would maintain or exceed their inflation-adjusted fiscal year 2023 value after fiscal year 2023 would be higher in each decade.

Reductions in annual disbursements could be effected by the compact trust fund committees at their discretion, without changes to the compact trust fund agreements. However, reductions in annual disbursements below the maximum amount would require each country to permanently adjust to having fewer resources for their budgets and economies than the compact grants provided.

Strategy 2: Additional annual contributions are made to the trust fund in fiscal years 2018 through 2023. We analyzed the likely effects of additional contributions equivalent to 5 percent of each country’s fiscal year 2016 GDP, relative to the baseline scenarios, for both the FSM and the RMI compact trust funds.

The average size of the disbursements would be greater.

Disbursement amounts would remain volatile from year to year if the balance in the C account is not sufficient to provide additional disbursements.

The risk of zero disbursements would be reduced but not eliminated.

The likelihood that the funds would maintain or exceed their inflation- adjusted fiscal year 2023 value after fiscal year 2023 would be higher.

Additional contributions to the FSM or RMI trust funds could be accepted at the discretion of compact trust fund committees, without changes to the compact trust agreements. However, unless the compact trust fund committees could identify other donors for these contributions, the countries would have to choose to reprogram existing revenues from other uses into compact trust fund contributions. The addition of funds from other donors would have no negative impact on the trust funds’ outlook if other conditions remained unchanged.

Potential Strategies That Would Permit Disbursement from the A Account

We analyzed three additional potential strategies that would involve calculating annual disbursements as a percentage of the FSM and RMI compact trust funds’ balance and which would permit disbursement from the A account. Disbursing from the A account would require changing the compact trust fund agreements, necessitating negotiation and agreement between the United States and each country and statutory enactment by the U.S. Congress. In strategy 3, disbursements are calculated as a fixed percentage of the funds’ moving average balance over the previous 3 years. In strategies 4 and 5, disbursements are calculated on the basis of the funds’ moving average balance over the previous 5 years as well as the committees’ determination of the target size for the funds’ balance or disbursements. All three potential strategies would require the FSM and the RMI to exchange a reduction in resources for more predictable disbursements in the longer term.

Strategy 3: The annual disbursement is set as a fixed percentage of the fund’s moving average balance over the previous 3 years, up to the maximum disbursement amount defined by the current trust fund agreement. We analyzed the likely effects of limiting annual disbursements to 5 percent of the moving average balance over the previous 3 years, relative to the baseline scenario for the FSM and the RMI compact trust funds.

In earlier years, average disbursements from the compact trust funds would be smaller than those in the baseline scenario; in later years, average disbursements would exceed those in the baseline scenario. For the FSM, the average disbursement would start to exceed that in the baseline scenario in the second decade after disbursements begin (fiscal years 2034-2043). For the RMI, the average disbursement would start to exceed that in the baseline scenario in the fourth decade after disbursements begin (fiscal years 2054-2063). Disbursement amounts would be less volatile from year to year than the volatility that could be experienced in the baseline scenario when the balance in the C account is not sufficient to provide additional disbursements.

The risk of zero disbursements would be eliminated.

The likelihood that the funds would maintain or exceed their inflation- adjusted fiscal year 2023 value after that year would be higher than in the baseline scenario.

Strategy 4: The amount of the annual disbursement is reduced if the compact trust fund’s moving average balance over the previous 5 years is lower than a primary target amount. We analyzed the likely effects of implementing this strategy, relative to the baseline scenario for the FSM and the RMI compact trust funds.

In the FSM, the average disbursement would be lower than that in the baseline scenario in earlier years but higher than that in the baseline scenario in the fourth decade after disbursements begin (i.e., fiscal years 2054-2063). In the RMI, the average disbursement would be lower than that in the baseline scenario in earlier years but would equal that in the baseline scenario in the fourth decade after disbursements begin (i.e., fiscal years 2054-2063). Disbursement amounts would be less volatile from year to year than the volatility that could be experienced in the baseline scenario when the balance in the C account is not sufficient to provide additional disbursements.

The risk of zero disbursements would be greatly reduced but not eliminated. In the FSM, the risk would be 55 percentage points lower than in the baseline scenario in the fourth decade after disbursements begin (i.e., fiscal years 2054-2063). In the RMI, the risk would be less than 5 percent in each decade.

The likelihood that the funds would maintain or exceed their inflation- adjusted fiscal year 2023 value after that year would be higher than in the baseline scenario.

Strategy 5: The target disbursement is set as 2.1 percent of the compact trust fund’s balance in fiscal year 2024. The disbursement amount is further decreased if the fund’s moving average balance over the previous 5 years is lower than the primary target balance. Our analysis projected the following effects of implementing this strategy relative to the baseline scenario for the FSM and the RMI compact trust funds:

For both countries, the average disbursement would be smaller than that in the baseline scenario in the first 3 decades after disbursements begin (i.e., fiscal years 2024-2053) but would exceed that in the baseline scenario in the fourth decade. Disbursement amounts would be less volatile from year to year than the volatility that could be experienced in the baseline scenario between 2024 and 2063 when the balance in the C account is not sufficient to provide additional disbursements.

The risk of zero disbursements would be almost eliminated.

The likelihood that the funds would maintain or exceed their inflation- adjusted fiscal year 2023 value would be much higher.

Figures 11 through 16 compare projected compact trust fund disbursements and fund balances in the baseline scenario with projected disbursements and fund balances for the five selected potential strategies for improving the trust funds’ outlook.

The amounts of disbursement reductions and additional contributions varied among the strategies examined in prior studies. To provide additional information about potential trust fund outcomes, we analyzed another four examples of the selected strategies that assumed a lower amount of additional trust fund contributions, lower disbursement reductions, or a lower percentage of the compact trust fund balance that could be withdrawn. Tables 13 and 14 show the results for all 9 analyses.

Appendix VIII: Status of Other Planned Actions in the FSM and RMI Decrement Management Plans

In addition to planning budget reductions in the FSM Long-Term Fiscal Framework (its decrement management plan) and the RMI Decrement Management Plan, the FSM and RMI planned other actions such as tax reforms and subsidy reductions to address the scheduled decrement in compact sector grants. The FSM implemented two of three planned actions and the RMI implemented one of four planned actions. The FSM did not implement unified tax reform measures but implemented a change in the formula for sharing compact sector grants with the FSM states and using planned surpluses to mitigate the effects of fiscal reforms. The RMI did not implement planned new taxes, reductions in subsidies to state- owned enterprises, or reductions in payments to Majuro landowners for the use of their land for utilities. The RMI did program a portion of its fishing fee surplus into the annual budget.

As of January 2018, the FSM national government had implemented two of three actions that the FSM Long-Term Fiscal Framework indicated the FSM would take in addition to budget reductions. 1. Implementing unified tax reform measures

Not implemented. The FSM Long-Term Fiscal Framework states that substantial effort and progress has been made towards comprehensive tax and revenue reform and that the FSM national and state governments anticipated that the Long-Term Fiscal Framework process would provide further impetus towards tax reform. However, according to FSM officials, two FSM states (Pohnpei and Yap) did not approve the Unified Revenue Act. According to FSM officials, the FSM is currently considering other models for tax reform and plans to revisit the issue in the future. 2. Reducing the national government’s share of compact grants and reallocating it to the FSM states Implemented. According to the Long-Term Fiscal Framework, FSM Public Law 18-12 reduced the national government’s share of fiscal year 2014 compact grants from 10 percent to 5 percent, with the amount of the reduction passed along to the FSM states. In May 2014, FSM Public Law 18-57 further reduced the national government’s share of compact grants to 0 percent and increased the amount of compact grants allocated to the state governments, according to the FSM. 3. Using planned surpluses for actions such as possible contributions to activities that mitigate the effects of fiscal reforms, the FSM’s compact trust fund, retiring debt, or reform costs.

Implemented. The FSM national government has made additional trust fund contributions but, according to FSM officials, has made a policy decision to make these contributions to the FSM Trust Fund instead of the compact trust fund.

As of January 2018, the RMI national government had implemented one of four other actions that its decrement management plan indicated it would take. 1. Implementing a value-added tax and net profits tax in 2017

Not implemented. Officials from the RMI Economic Policy, Planning, and Statistics Office and Ministry of Foreign Affairs confirmed that tax reform has not been implemented due to political challenges. However, a tax task force has been established to revisit tax revenue reforms. 2. Programming 80 percent of unallocated Marshall Islands Marine Resources Authority fishing fee surplus into the annual budget in fiscal year 2015 and using the remaining 20 percent to develop the fishing industry.

Implemented. The RMI programmed a portion of its fishing fees into the annual budget in fiscal years 2015 through 2017—$15.8 million in fiscal year 2015, $26.3 million in fiscal year 2016, and $40 million in fiscal year 2017. Although fishing fees were programmed into the budget, according to RMI’s Office of Compact Implementation, the formula allocating 80 percent of fishing fee revenue into the annual budget and the remaining 20 percent to develop the fishing industry is part of proposed RMI legislation but has not become law. 3. Reducing state-owned enterprise subsidies by 10 percent in fiscal years 2016 and 2018.

Not implemented. The RMI national government did not reduce the total amount of state-owned enterprise subsidies by 10 percent in fiscal years 2016 as committed in the 2014 decrement management plan. Audit reports for state-owned enterprises in fiscal years 2015 and 2016 indicate that, while the RMI reduced subsidy amounts for some state-owned enterprises, other subsidy amounts increased and overall subsidies were higher in both fiscal years 2015 and 2016 than in fiscal year 2014. See table 15. for the government’s use of their land for utilities by 20 percent in fiscal years 2016, 2018, and 2021.

Not implemented. The RMI national government has not reduced government transfers to Majuro landowners to compensate for the government’s use of their land for utilities due to political challenges, according to RMI officials. RMI Ministry of Finance officials stated that, as of January 2018, there had been no reductions in government transfers to Majuro landowners. According to RMI government officials, the total rent payment bill has in fact increased as utilities in Majuro have expanded.

Appendix IX: Comments from the Department of the Interior

Appendix X: Comments from the U.S. Postal Service

Now on page 68.

Appendix XI: Comments from the Federated States of Micronesia

GAO Comments

1. The FSM refers to our testimony in 2002 regarding the potential for the FSM compact trust fund to not provide funds sufficient to cover the estimated value of expiring federal services as early as 2002. 2. The FSM includes a graphic showing the effect of the partial inflation adjustments and the decrement in the compact sector grants. We include a similar portrayal of this analysis in figure 10 in this report. 3. The FSM states that the amount of the decrement in compact sector grants that is used for annual contributions to the FSM compact trust fund should be recorded as an FSM contribution to the fund. However, Section 215 of the FSM compact refers to the annually decreasing amounts provided to the compact trust fund as set forth in Section 216 of the FSM compact as United States contributions to the compact trust fund.

Appendix XII: Comments from the Republic of the Marshall Islands

GAO Comments

1. The RMI states that, absent accountability issues, the maximum annual disbursement amount should be disbursed from the compact trust fund. However, as our report notes, although the compact trust fund agreements state the maximum allowable disbursement level, they do not establish or guarantee a minimum disbursement level. 2. The RMI states that the 2-year delay in investing the compact trust fund will result in a compounded total loss of $33.6 million by the end of fiscal year 2023. Our 2007 analysis of the trust funds included information about the delays in establishing the trust funds. We did not update our 2007 analysis of the loss in income due to the delay in investing the compact trust fund for this report. 3. The RMI notes that the amended compacts' implementing legislation extended several important federal programs. Appendix IV of this report presents our conclusions, based on our analysis of current law, that the RMI will remain eligible as of the end of fiscal year 2023 for special education programs and for some programs replaced by the supplemental education grant.

Appendix XIII: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact named above, Emil Friberg (Assistant Director), Ming Chen, Neil Doherty, Mark Dowling, Reid Lowe, Moon Parks, Shaundra Patterson, and Michael Simon made key contributions to this report. Justin Fisher, Jeff Isaacs, Julie Hirshen, Risto Laboski, Courtney LaFountain, and Jeffery Malcolm provided technical assistance.