In 1986, the United States and the FSM and the RMI entered into the Compact of Free Association. This Compact represented a new phase of the unique and special relationship that has existed between the United States and these island areas since World War II. It also represented a continuation of U.S. rights and obligations first embodied in a U.N. trusteeship agreement that made the United States the Administering Authority of the Trust Territory of the Pacific Islands. The Compact provided a framework for the United States to work toward achieving its three main goals: (1) to secure self-government for the FSM and the RMI, (2) to assist the FSM and the RMI in their efforts to advance economic development and self-sufficiency, and (3) to ensure certain national security rights for all of the parties. The first goal has been met. The FSM and the RMI are independent nations and are members of international organizations such as the United Nations. The second goal of the Compact – advancing economic development and self-sufficiency for both countries – was to be accomplished primarily through U.S. direct financial payments (to be disbursed and monitored by the U.S. Department of the Interior) to the FSM and the RMI. For the 15- year period covering 1987 through 2001, funding was provided at levels that decreased every 5 years. For 2002 and 2003, while negotiations to renew expiring Compact provisions were ongoing, funding levels increased to equal an average of the funding provided during the previous 15 years. Thus, funds available to the two governments were “bumped-up” during the last 2 years of assistance. For 1987 through 2003, U.S. assistance to the FSM and the RMI to support economic development is estimated on the basis of Interior data, to be about $2.1 billion. We have found that many Compact-funded projects in the FSM and the RMI experienced problems because of poor planning and management, inadequate construction and maintenance, or misuse of funds. Further the U.S., FSM, and RMI governments provided little accountability over Compact expenditures and have not ensured that funds were spent effectively or efficiently. Economic self-sufficiency has not been achieved. Although total U.S. assistance (Compact direct funding as well as U.S. programs and services) as a percentage of total government revenue has fallen in both countries (particularly in the FSM), the two nations remain highly dependent on U.S. funds. U.S. direct assistance has maintained standards of living that are higher than could be achieved in the absence of U.S. support. In addition, U.S. programs have been extended to the FSM and the RMI to provide a wide range of critical services, such as health care, education, telecommunications, and job training, but in most cases local conditions have impaired the programs’ effectiveness. The third goal of the Compact – securing national security rights for all parties – has been achieved. At the time that the Compact was negotiated, the United States was concerned about the use of the islands of the FSM and the RMI as “springboards for aggression” against the United States, as they had been used in World War II, and the Cold War incarnation of this threat – the Soviet Union. The Compact and its related agreements established several key defense rights for all three countries. The Compact obligates the United States to defend the FSM and the RMI against an attack or the threat of attack in the same way it would defend its own citizens. The Compact also provides the United States with the right of “strategic denial,” the ability to prevent access to the islands and their territorial waters by the military personnel of other countries or the use of the islands for military purposes. In addition, the Compact grants the United States a “defense veto” over actions by the FSM or the RMI governments that the United States determines are incompatible with its authority and responsibility for security and defense matters in these countries. Finally, through a Compact-related agreement, the United States secured continued access to military facilities on Kwajalein Atoll in the RMI through 2016. In a previous report, we identified Kwajalein Atoll as the key U.S. defense interest in the two countries. Of these rights, only the defense veto is due to expire in 2003 if not renegotiated. Another aspect of the special relationship between the FSM and the RMI and the United States involves the unique immigration rights that the Compact grants. Through the original Compact, citizens of both nations are allowed to live and work in the United States as “nonimmigrants” and can stay for long periods of time, with few restrictions. Further, the Compact exempted FSM and RMI citizens from meeting U.S. passport, visa, and labor certification requirements when entering the United States. In recognition of the potential adverse impacts that Hawaii and nearby U.S. commonwealths and territories could face as a result of an influx of FSM and RMI citizens, the Congress authorized Compact impact payments to address the financial impact of these nonimmigrants on Guam, Hawaii, and the Commonwealth of the Northern Mariana Islands (CNMI). By 1998, more than 13,000 FSM and RMI citizens had made use of the Compact immigration provisions and were living in the three areas. The governments of the three locations have provided the U.S. government with annual Compact nonimmigrant impact estimates; for example, in 2000 the total estimated impact for the three areas was $58.2 million. In that year, Guam received $7.58 million in impact funding, while the other two areas received no funding. In the fall of 1999, the United States and the two Pacific Island nations began negotiating economic assistance and defense provisions of the Compact that were due to expire. Immigration issues were also addressed. According to the State Department, the aims of the amended Compacts are to (1) continue economic assistance to advance self-reliance, while improving accountability and effectiveness; (2) continue the defense relationship, including a 50-year lease extension (beyond 2016) of U.S. military access to Kwajalein Atoll in the RMI; (3) strengthen immigration provisions; and (4) provide assistance to lessen the impact of Micronesian migration on Hawaii, Guam, and the CNMI. Under the amended Compacts with the FSM and the RMI, new congressional authorizations of approximately $3.5 billion in funding would be required over the next 20 years, with a total possible authorization through 2086 of $6.6 billion. Economic assistance would be provided to the two countries for 20 years – from 2004 through 2023 – with all subsequent funding directed to the RMI for continued U.S. access to military facilities in that country. Under the U.S. proposals, annual grant amounts to each country would be reduced each year in order to encourage budgetary self-reliance and transition the countries from receiving annual U.S. grant funding to receiving annual trust fund earnings. Annual grant assistance to the FSM would fall from a real value of $76 million in fiscal year 2004 to a real value of $55 million in fiscal year 2023. Annual grant assistance to the RMI would fall from a real value of $35 million to a real value of $24 million over the same period. This decrease in grant funding, combined with FSM and RMI population growth, would also result in falling per capita grant assistance over the funding period – particularly for the RMI. If the trust funds established in the amended Compacts earn a 6 percent rate of return, the FSM trust fund would be insufficient to replace expiring annual grants. The RMI trust fund would replace grants in fiscal year 2024 but would become insufficient for this purpose by fiscal year 2040. Under the amended Compacts with the FSM and the RMI, new congressional authorizations of approximately $6.6 billion could be required for U.S. payments from fiscal years 2004 to 2086, of which $3.5 billion would be required for the first 20 years of the Compacts (see table 1). The share of new authorizations to the FSM would be about $2.3 billion and would end after fiscal year 2023. The share of new authorizations to the RMI would be about $1.2 billion for the first 20 years, with about $300 million related to extending U.S. military access to Kwajalein Atoll through 2023. Further funding of $3.1 billion for the remainder of the period corresponds to extended grants to Kwajalein and payments related to U.S. military use of land at Kwajalein Atoll. The cost of this $6.6 billion new authorization, expressed in fiscal year 2004 U.S. dollars, would be $3.8 billion (see the appendix for a breakout of estimated new U.S. authorizations to the FSM and the RMI in fiscal year 2004 U.S. dollars). This new authorized funding would be provided to each country in the form of annual grant funds targeted to priority areas (such as health, education, and infrastructure), audit assistance, and disaster assistance; contributions to a trust fund for each country such that trust fund earnings would become available to the FSM and the RMI in fiscal year 2024 to replace expiring annual grants; payments the U.S. government makes to the RMI government that the RMI transfers to Kwajalein landowners to compensate them for the U.S. use of their lands for defense sites; and an extension of federal services that have been provided under the original Compact but are due to expire in fiscal year 2003.