oversight

Compact of Free Association: Proposed U.S. Assistance to Palau through Fiscal Year 2024

Published by the Government Accountability Office on 2012-09-10.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                             United States Government Accountability Office

GAO                          Testimony
                             Before the Subcommittee on Fisheries,
                             Wildlife, Oceans, and Insular Affairs,
                             Committee on Natural Resources, House
                             of Representatives
For Release on Delivery
Expected at 2:00 p.m. EDT
Monday, September 10, 2012   COMPACT OF FREE
                             ASSOCIATION
                             Proposed U.S. Assistance to
                             Palau through Fiscal Year
                             2024
                             Statement of David Gootnick, Director
                             International Affairs and Trade




GAO-12-798T
                                              September 10, 2012

                                              COMPACT OF FREE ASSOCIATION
                                              Proposed U.S. Assistance to Palau through Fiscal
                                              Year 2024
Highlights of GAO-12-798T, a testimony
before the Subcommittee on Fisheries,
Wildlife, Oceans, and Insular Affairs,
Committee on Natural Resources, House of
Representatives


Why GAO Did This Study                        What GAO Found
The Compact of Free Association               The Agreement would provide decreasing assistance, totaling approximately
between the United States and the             $215 million through fiscal year 2024 and includes the following:
Republic of Palau, which entered into             direct economic assistance ($107.5 million) for Palau government operations;
force in 1994, provided for several               infrastructure project grants ($40 million) to build mutually agreed projects;
types of assistance aimed at promoting            infrastructure maintenance fund ($28 million) for maintaining the Compact
Palau’s self-sufficiency and economic              Road, Palau’s primary airport, and certain other major U.S.-funded projects;
advancement. Included were 15 years               fiscal consolidation fund ($10 million) to assist Palau in debt reduction; and
of direct assistance to the Palau                 trust fund contributions ($30.25 million) in addition to the $70 million
government; contributions to a trust               contributed under the compact
fund meant to provide Palau $15
million each year in fiscal years 2010        Assistance to Palau Specified in the Agreement
through 2044; construction of a road
system, known as the Compact Road;
and federal services such as postal,
weather, and aviation. U.S. agencies
also provided discretionary federal
programs related to health, education,
and infrastructure. In 2008, GAO
projected that total assistance in fiscal
years 1994 through 2009 would
exceed $852 million.
In September 2010, the United States
and Palau signed an agreement (the
Agreement) that would, among other
things, provide for additional
assistance to Palau beginning in fiscal
year 2011 and modify its trust fund.
Currently, there are two bills pending
before Congress to implement the
                                              Notes: All dollar amounts are in nominal dollars (i.e., unadjusted for inflation). Funds were not
Agreement.                                    provided in fiscal years 2011 or 2012 to date for infrastructure projects, the infrastructure
                                              maintenance fund, or the fiscal consolidation fund.
In this testimony, GAO updates a
November 2011 testimony on (1) the            Under the Agreement, the United States would contribute to the trust fund in
Agreement’s provisions for economic           fiscal years 2013 through 2023, and Palau would reduce its withdrawals by $89
assistance to Palau, (2) its impact on        million in fiscal years 2010 through 2023. GAO projects that the fund would have
the trust fund’s likelihood of sustaining     a 90 percent likelihood of sustaining payments through fiscal year 2044 with
scheduled payments through fiscal             these changes, versus 40 percent without these changes.
year 2044, (3) the projected role of          Estimates prepared for the Palau government project declining reliance on U.S.
U.S. assistance in Palau government           assistance under the Agreement—from 28 percent of government revenue in
revenues, and (4) the pending                 fiscal year 2011 to 2 percent in fiscal year 2024—and growing reliance on trust
legislation to implement the                  fund withdrawals and domestic revenues. The estimates show trust fund
Agreement. GAO reviewed current               withdrawals rising from 5 percent to 24 percent and domestic revenues rising
trust fund data and new pending               from 40 to 59 percent, of total government revenue. According to the estimates,
legislation for this testimony.               U.S. assistance in fiscal years 2011 through 2024 would total $427 million, with
                                              discretionary federal programs accounting for about half of that amount.
                                              Congress has not approved legislation to implement the Agreement as of
                                              September 2012. Pending Senate legislation would implement the Agreement
View GAO-12-798T. For more information,
contact David Gootnick at (202) 512-3149 or
                                              and appropriate funds to do so. Pending House legislation would implement the
gootnickd@gao.gov.                            agreement, apply an inflation adjustment to assistance payments, and shift the
                                              timing of certain assistance payments to reflect the fact that 2011 has passed.
                                                                                                 United States Government Accountability Office
Chairman Fleming, Ranking Member Sablan, and Members of the
Subcommittee:

I am pleased to be here today to discuss the September 2010 agreement
between the U.S. and Palau governments.1

The Compact of Free Association between the Government of the United
States and the Government of the Republic of Palau, which entered into
force in 1994,2 provided for several types of assistance aimed at
promoting Palau’s economic advancement and eventual self-sufficiency.3
In addition to establishing Palauan sovereignty and U.S.-Palau security
and defense arrangements, the compact provided economic assistance
to Palau.4 This assistance comprised, among other things, direct
economic assistance for 15 years to the Palau government; the
establishment of a trust fund intended to provide Palau $15 million
annually from 2010 through 2044; investments in infrastructure, including
a major road; and the provision of federal services, such as postal,
weather, and aviation. The compact also established a basis for U.S.
agencies to provide discretionary federal programs related to health,
education, and infrastructure. In June 2008, we projected that U.S.
assistance to Palau from 1995 through 2009 would exceed $852 million,
with assistance under the compact accounting for about 68 percent and
assistance through discretionary programs accounting for about 31
percent.5 We also reported in 2008 that the likelihood of the Palau trust



1
 The Agreement between the Government of the United States of America and the
Government of the Republic of Palau Following the Compact of Free Association Section
432 Review (Sept. 3, 2010).
2
 The Compact of Free Association between the Government of the United States of
America and the Government of the Republic of Palau (Oct. 1, 1994).
3
 See Proclamation 6726, Placing into Full Force and Effect the Compact of Free
Association with the Republic of Palau, 59 Fed. Reg. 49777 (Sept. 27, 1994). Congress
approved the Compact of Free Association in Public Law 99-658 on November 14, 1986,
and Public Law 101-219 on December 12, 1989. The grant funds specified by the
compact are backed by the full faith and credit of the U.S. government.
4
 Unless otherwise noted, all years cited are fiscal years (Oct. 1-Sept. 30). In addition, all
dollar amounts in this report are in nominal dollars (i.e., unadjusted for inflation).
5
 GAO, Compact of Free Association: Palau's Use of and Accountability for U.S.
Assistance and Prospects for Economic Self Sufficiency, GAO-08-732 (Washington, D.C.:
June 10, 2008).




Page 1                                                                            GAO-12-798T
fund’s being able to sustain the planned payments through 2044 was
uncertain.

The September 2010 agreement between the U.S. and Palau
governments (the Agreement) followed a formal review of the compact’s
terms required 15 years after the compact entered into force.6 Provisions
of the Agreement would, among other things, extend economic
assistance to Palau beyond the original 15 years and modify trust fund
arrangements. The Agreement establishes an assistance schedule
beginning in 2011. There are currently two bills pending before the
Congress to approve and implement the Agreement. A bill now pending
before the U.S. Senate would approve the Agreement and also
appropriate funds to implement it.7 However, the Senate bill does not
reflect the fact that fiscal year 2011 has passed.8 A bill now pending
before the House would approve the agreement, apply an inflation
adjustment to assistance payments, and shift the timing of certain
assistance payments to reflect the passage of fiscal year 2011.9

The Senate Committee on Energy and National Resources held a hearing
to review the pending bill on June 16, 2011; the Subcommittee on Asia
and the Pacific of the House Committee on Foreign Affairs held a hearing
to assess the formal review and proposed Agreement on November 30,
2011 We testified at both hearings and described the terms of the



6
 Section 432 of the compact provides for the U.S. and Palau governments to formally
review the terms of the compact and its related agreements and to consider the overall
nature and development of their relationship, on the 15th, 30th, and 40th anniversaries of
the compact’s effective date. The governments are to consider the operating requirements
of the government of Palau and its progress in meeting the development objectives set
forth in section 231(a) of the compact. The terms of the compact shall remain in force until
otherwise amended or terminated pursuant to title four of the compact.
7
 Senate Bill 343, as introduced in the Senate, amends Title I of Public Law 99-658;
approves the results of the 15-year review of the compact, including the Agreement; and
appropriates funds for the purposes of the amended Public Law 99-658 for fiscal years
ending on or before September 30, 2024, to carry out the agreements resulting from the
review. S. 343, 112th Cong. (2011).
8
S. 343, as introduced in the Senate.
9
 House Bill 6040, as introduced in the House, amends Title I of Public Law 99-658;
approves the results of the 15-year review of the compact, including the Agreement; shifts
the schedule of certain assistance payments; creates an annual reporting requirement for
the Department of the Interior; and includes an offset provision. H.R. 6040, 112th Cong.
(2012).




Page 2                                                                         GAO-12-798T
             Agreement, assessed trust fund balances and disbursement plans under
             various assumptions and investment returns, and examined single audit
             reports and budget estimates prepared for the Palau government.10

             My statement today updates our November 2011 statement.11 In
             particular, it describes (1) the extension of economic assistance to Palau
             as outlined in the Agreement, (2) the impact that this assistance would
             have on the Palau trust fund’s sustainability, (3) the projected role of U.S.
             assistance in Palau government revenues, and (4) the pending legislation
             to implement the Agreement. We used recent data from the Palau trust
             fund to update its sustainability, and we reviewed the bill pending before
             the House that was introduced in July 2012.12 In addition, since Congress
             has not approved legislation implementing the agreement, we note that
             the Department of the Interior has provided direct economic assistance to
             Palau. We conducted this work from August and September 2012 in
             accordance with all sections of GAO’s Quality Assurance Framework that
             are relevant to our objectives. The framework requires that we plan and
             perform the engagement to obtain sufficient and appropriate evidence to
             meet our stated objectives and to discuss any limitations in our work. We
             believe that the information and data obtained, and the analysis we
             conducted, provide a reasonable basis for any findings and conclusions in
             this product.


             Palau consists of 8 main islands and more than 250 smaller islands, with
Background   a total land area of roughly 190 square miles, located approximately 500
             miles southeast of the Philippines. About 20,000 people live in Palau,
             concentrated largely in one urban center around the city of Koror, and
             more than one-quarter of the population is non-Palauan.13 Palau’s


             10
               GAO, Compact of Free Association: Proposed U.S. Assistance to Palau and Its Likely
             Impact, GAO-11-559T (Washington, D.C.: June 16, 2011).
             11
               GAO, Compact of Free Association: Proposed U.S. Assistance to Palau for Fiscal Years
             2011-2024, GAO-12-249T (Washington, D.C.: Nov. 30, 2011).
             12
              H.R. 6040.
             13
               Palau’s private sector relies heavily on foreign workers, mostly from the Philippines. We
             reported in 2008 that since 1994, foreign workers, as registered with Palau’s Social
             Security Office, had grown to account for half of Palau’s total labor force. Because many
             of these foreign workers send wage income back to their home nations, in 2005 the
             annual net outflow of remittances from Palau equaled an estimated 5.5 percent of its
             gross domestic product (GDP).




             Page 3                                                                         GAO-12-798T
economy is heavily dependent on its tourism sector and on foreign aid
from the United States, Japan, and Taiwan.14 Similar to many small island
economies, Palau’s public sector spending represents a significant
percentage of its gross domestic product (GDP).15

U.S. relations with Palau began when American forces liberated the
islands near the end of World War II. In 1947, the United Nations
assigned the United States administering authority over the Trust
Territory of the Pacific Islands, which included what are now the
Federated States of Micronesia, the Republic of the Marshall Islands, the
Commonwealth of the Northern Mariana Islands, and Palau. Palau
adopted its own constitution in 1981. The U.S. and Palau governments
concluded a Compact of Free Association in 1986; the compact entered
into force on October 1, 1994. The Department of the Interior’s (Interior)
Office of Insular Affairs (OIA) has primary responsibility for monitoring and
coordinating all U.S. assistance to Palau, and the Department of State
(State) is responsible for government-to-government relations.

Key provisions of the compact and its subsidiary agreements address the
sovereignty of Palau, types and amounts of U.S. assistance, security and
defense authorities, and periodic reviews of compact terms. Table 1
summarizes key provisions of the Palau compact and related subsidiary
agreements.




14
  The International Monetary Fund (IMF) projected that in 2010, Palau’s GDP was an
estimated $218 million and reported that Palau’s GDP per capita was about $10,500.
Business and tourist arrivals were projected to be 78,000 in 2010. See IMF, Republic of
Palau Staff Report for the Article IV Consultation (Apr. 12, 2010).
15
  According to the IMF, in 2010, Palau’s public sector spending was projected at
approximately 42 percent of its GDP.




Page 4                                                                       GAO-12-798T
Table 1: Key Provisions of Palau Compact of Free Association and Subsidiary Agreements

Compact section          Description of key provisions
Title one:               Sovereignty
Government Relations     Established Palau as a self-governing nation with the capacity to conduct its own foreign affairs.
                         Immigration privileges
                         Provided Palauan citizens with certain immigration privileges, such as the rights to work and live in the
                         United States indefinitely and to enter the United States without a visa or passport. This privilege remains in
                         effect as long as the compact agreement is not amended by mutual agreement or mutually or unilaterally
                         terminated.
Title two:               Compact direct assistance
Economic Relations       Established 15-year term of budgetary support for Palau, beginning on compact’s effective date. This
                         support included direct assistance for current account operations and maintenance and for specific needs
                         such as energy production, capital improvement projects, health, and education.
                         Trust fund
                         Required the United States to contribute to a trust fund for Palau.
                         Compact Road
                                                                                                  a
                         Required the United States to construct a road system (the Compact Road).
                         Compact federal services
                         Required the United States to make available certain federal services and related programs to Palau, such
                         as postal, weather, and aviation. The compact subsidiary agreement implementing such services was in
                         force until October 1, 2009.b
                         Accountability for compact funds
                         Required Palau to report on its use of compact funds and required the U.S. government, in consultation with
                         Palau, to implement procedures for periodic audits of all grants and other assistance.c
Title three:             U.S. authority for security and defense matters
Security and Defense     Established that the United States has full authority and responsibility for security and defense matters in or
Relations                relating to Palau, would take action to meet the danger of an attack on Palau, and may conduct activities on
                         land, water, and airspace as necessary.
                         Strategic denial
                         Foreclosed Palau to the military of any nation except the United States, unless they are invited by the United
                         States and under the control of the U. S. armed forces.
                         U.S. defense sites and operating rights
                         Established that the United States may establish land and sea defense sites in Palau and has certain military
                         operating rights. The subsidiary agreement implementing this provision provides the United States exclusive
                         use of certain land adjoining the airport and certain submerged land in Malakal Harbor and remains in effect
                         through 2044.
                         Service in the armed forces
                         Established eligibility of Palau citizens to serve in the U.S. armed forces.
                         The provisions on U.S. authority for security and defense matters, U.S. defense sites and operating rights,
                         and service in the armed forces remain in effect unless the compact is terminated by mutual agreement or, if
                         the compact is unilaterally terminated, until October 1, 2044, and thereafter as mutually agreed. The
                         strategic denial provision remains in effect through 2044 and thereafter until terminated or otherwise
                         amended by mutual consent.




                                         Page 5                                                                          GAO-12-798T
Compact section      Description of key provisions
Title four:          Established general provisions regarding approval and effective date of the compact, conference and
General Provisions   dispute resolution procedures, and compact termination procedures. Required reviews of its terms on the
                     15th, 30th, and 40th anniversaries of the compact’s entry into force—that is, in 2009, 2024, and 2034,
                     respectively.
                                    Source: GAO analysis of the Compact of Free Association between the Government of the United States and the Government of the
                                    Republic of Palau.

                                    Notes:
                                    The compact’s subsidiary agreements relate to specific titles of the compact and, in many cases,
                                    contain implementing details of compact provisions.
                                    Years are fiscal (Oct. 1-Sept. 30).
                                    a
                                     The compact called for the United States to build the Compact Road according to mutually agreed
                                    specifications before October 1, 2000. The road was completed and turned over to Palau on
                                    October 1, 2007. See GAO-08-732, appendix V, for more information.
                                    b
                                     Federal Programs and Services Agreement Concluded Pursuant to Article II of Title Two and Section
                                    232 of the Compact of Free Association, which took effect in 1995, established the legal status of
                                    programs and related services, federal agencies, U.S. contractors, and personnel of U.S. agencies
                                    implementing both compact federal services and discretionary federal programs in Palau. Under this
                                    agreement, the United States Postal Service (USPS) conveys mail between the United States and
                                    Palau and offers other services such as Priority Mail®, Collect on Delivery, and USPS Domestic
                                    Money Orders. Palau maintains its own postal service for internal mail delivery. Under this
                                    agreement, the National Weather Service reimburses Palau for the cost of operating its weather
                                    station in Palau, which performs upper air observations twice daily and as requested for the purpose
                                    of Palau’s airport operations and the tracking of cyclones that may impact other U.S. territories such
                                    as Guam; and the Federal Aviation Administration provides aviation services to Palau, including en-
                                    route air traffic control from the mainland United States, flight inspection of airport navigation aids,
                                    and technical assistance and training.
                                    c
                                     In August 2012, the government of Palau submitted its annual single audit for fiscal year 2010 that
                                    was due in June 2011. However, the government of Palau has not yet submitted its annual single
                                    audit for fiscal year 2011 that was due in June 2012.


                                    In addition to the U.S. assistance provided under the compact, U.S.
                                    agencies—the Department of Education, the Department of Health and
                                    Human Services (HHS), and Interior, among others—provide
                                    discretionary federal programs in Palau as authorized by U.S. legislation16
                                    and with appropriations from Congress. (See app. II for a complete listing
                                    of these programs in Palau.)

                                    In our 2008 report, we projected that U.S. assistance to Palau from 1995
                                    through 2009 would exceed $852 million. Of this total, economic
                                    assistance under the compact accounts for a projected 68 percent and




                                    16
                                      The compact’s federal programs and services agreement, establishing the legislative
                                    framework for the provision of discretionary federal programs in Palau, was in force until
                                    October 1, 2009. These services continued under program authority in 2010 and 2011.




                                    Page 6                                                                                                        GAO-12-798T
discretionary federal programs account for a projected 31 percent (see
fig. 1).17

Figure 1: U.S. Assistance to Palau in 1995-2009 as Projected in 2008




Notes:
Years are fiscal (Oct. 1-Sept. 30), and dollar amounts are in nominal dollars (i.e., unadjusted for
inflation).
Percentages may not sum to 100 because of rounding.
Amounts shown for compact direct assistance, compact trust fund contributions, and the Compact
Road are based on Interior’s Office of Insular Affairs’ actual and estimated payments to Palau for
1995-2009, as reported in Interior’s budget justification to Congress for 2009.
Amount shown for compact federal services is based on GAO estimates of past expenditures by the
National Weather Service, U.S. Postal Service, and Federal Aviation Administration.




17
  GAO-08-732.




Page 7                                                                                    GAO-12-798T
                            Amount shown for estimated discretionary federal programs is the sum of (1) U.S. agency program
                            expenditures as reported in single audits for 1995-2006 for the Palau national government and for
                            1997-2006 for the Palau Community Action Agency and the Palau Community College, (2) GAO
                            estimates of U.S. agency program expenditures for 2007-2009, and (3) GAO estimates of DOD Civic
                            Action Team costs for 1995-2009. Estimated and projected federal program expenditures do not
                            include the value of U.S. loans to Palau. For more information, see GAO-08-732.




                            The September 2010 Agreement between the U.S. and Palau
Agreement Would             governments would extend assistance to Palau to 2024 but steadily
Extend U.S.                 reduce the annual amount provided. The Agreement would also extend
                            the authority and framework for U.S. agencies to continue compact
Assistance for 15           federal services and discretionary federal programs.18
Years, with Annual
Decreases
Assistance to Palau Would   Key provisions of the Agreement would include, among others, extending
Decline through 2024        direct economic assistance to Palau, providing infrastructure project
                            grants and contributions to an infrastructure maintenance fund,
                            establishing a fiscal consolidation fund, and making changes to the trust
                            fund. U.S. assistance to Palau under the Agreement would total
                            approximately $215 million through 2024.19

                            Legislation implementing the Agreement was not approved by Congress
                            during 2011. Department of the Interior provided $13.1 million for direct
                            economic assistance in 2011 and again in 2012; however, funds were not
                            provided either year for infrastructure projects, the infrastructure
                            maintenance fund, or the fiscal consolidation fund.

                                Direct economic assistance ($107.5 million). Under the Agreement,
                                 the U.S. government would provide direct economic assistance—


                            18
                               Other provisions in the Agreement would define reporting and auditing requirements and
                            passport requirements. The Agreement would require that, by 2018, Palau resolve all
                            deficiencies identified in annual single audit reports, which are required by the Compact’s
                            fiscal procedures agreement, such that no single audit report recommendations or
                            deficiencies dating from before 2016 remain. In addition, the Agreement alters the entry
                            procedures for citizens of Palau visiting the United States, requiring them to present a
                            valid machine-readable passport to travel to the United States.
                            19
                              The compact provided for direct assistance to Palau only through 2009. For 2010
                            through 2012, Interior provided $13.1 million for direct assistance to Palau each year. For
                            2013, Interior’s Budget Justification proposed $34 million in direct assistance, while the
                            Agreement provides for $25.5 million.




                            Page 8                                                                              GAO-12-798T
     budgetary support for Palau government operations and specific
     needs such as administration of justice and public safety, health, and
     education—amounting to $13 million in 2011 and declining to $2
     million by 2023.20 The Agreement also calls for the U.S. and Palau
     governments to establish a five-member Advisory Group to provide
     annual recommendations and timelines for economic, financial, and
     management reforms. The Advisory Group must report on Palau’s
     progress in implementing these or other reforms, prior to annual U.S.-
     Palau economic consultations.21 These consultations are to review
     Palau’s progress in achieving reforms22 such as improvements in
     fiscal management, reducing the public sector workforce and salaries,
     reducing government subsidization of utilities, and tax reform. If the
     U.S. government determines that Palau has not made significant
     progress in implementing meaningful reforms, direct assistance
     payments may be delayed until the U.S. government determines that
     Palau has made sufficient progress.

    Infrastructure projects ($40 million). Under the Agreement, the U.S.
     government would provide U.S. infrastructure project grants to Palau
     for mutually agreed infrastructure projects—$8 million annually through
     2013,23 $6 million in 2014, and $5 million in both 2015 and 2016. The
     Agreement requires Palau to provide a detailed project budget and
     certified scope of work for any projects receiving these funds.

    Infrastructure maintenance fund ($28 million). Under the Agreement,
     the U.S. government would make contributions to a fund to be used
     for maintenance of U.S.-financed major capital improvement projects,


20
  Congress did not pass legislation appropriating funds for this assistance in 2011 and
therefore the earliest this assistance can begin is 2012.
21
 The Agreement requires that Palau undertake economic, legislative, financial, and
management reforms giving due consideration to those identified by the IMF; the Asian
Development Bank; and other creditable institutions, organizations, or professional firms.
22
  The compact requires that the United States and Palau consult annually regarding
Palau’s economic activities and progress in the previous year, as described in a report
that Palau must submit each year. Our 2008 report noted that Palau had met reporting
conditions associated with direct assistance but that, contrary to compact requirements,
the bilateral economic consultations had not occurred on an annual basis; and had been
informal and resulted in no written records. See GAO-08-732.
23
  Under the Agreement, the U.S. government would have provided U.S. infrastructure
project grants amounting to $8 million in 2011; however, Congress did not pass legislation
appropriating such funds in 2011.




Page 9                                                                        GAO-12-798T
     including the Compact Road and Airai International Airport.24 Through
     2024,25 the U.S. government would contribute $2 million annually, and
     the Palau government would contribute $600,000 annually to the
     fund.26

    Fiscal consolidation fund ($10 million). Under the Agreement, the U.S.
     government would provide grants of $5 million each in 201127 and
     2012, respectively, to help the Palau government reduce its debts.
     Unless agreed to in writing by the U.S. government, these grants
     cannot be used to pay any entity owned or controlled by a member of
     the government or his or her family, or any entity from which a
     member of the government derives income. U.S. creditors must
     receive priority, and the government of Palau must report quarterly on
     the use of the grants until they are expended.

    Trust fund ($30.25 million). Under the Agreement, the U.S.
     government would contribute $30.25 million to the fund from 2013
     through 2023. The government of Palau will reduce its previously
     scheduled withdrawals from the fund by $89 million.28 From 2024
     through 2044, Palau can withdraw up to $15 million annually, as
     originally scheduled. Moneys from the trust fund account cannot be
     spent on state block grants, operations of the office of the President of
     Palau, the Olibiil Era Kelulau (Palau National Congress), or the Palau


24
  In 2008, we reported that Palau and U.S. officials had expressed concerns about
Palau’s ability to maintain the Compact Road in a condition that would allow for the
desired economic development. We also reported that Palau made initial efforts to
maintain the road, but at levels that would cause the road to deteriorate over time and
would not provide the economic development benefits envisioned for the people of Palau.
See GAO-08-732.
25
  The Agreement states that the United States shall provide a grant beginning in 2011.
However, Congress did not pass legislation appropriating funds for this purpose in 2011
and therefore the earliest the U.S. contributions can begin is 2012.
26
  Under the compact, Palau owes the United States a total of $3 million. Under the
Agreement, Palau would deposit $3 million in the infrastructure maintenance fund but not
expend it. Any future income derived from the $3 million must be used exclusively for the
maintenance of the Compact Road.
27
  Although the Agreement states that the United States shall provide a grant beginning in
2011, Congress did not pass legislation appropriating funds for this purpose in 2011 and
therefore the earliest the U.S. contributions can begin is 2012.
28
  Under the Agreement, Palau would withdraw $5 million annually through 2013 and
gradually increase its maximum withdrawal from $5.25 million in 2014 to $13 million in 2023.




Page 10                                                                        GAO-12-798T
                                              Judiciary. Palau must use $15 million of the combined total of the trust
                                              fund disbursements and direct economic assistance exclusively for
                                              education, health, and the administration of justice and public safety.

                                         Annual U.S. assistance to Palau under the Agreement would decline from
                                         roughly $28 million in 2011 to $2 million in 2024. Figure 2 details the
                                         timeline and composition of assistance outlined in the Agreement.

Figure 2: U.S. Assistance to Palau for 2011-2024, as Outlined in the Agreement




                                         Notes:
                                         Years are fiscal (Oct. 1-Sept. 30), and dollar amounts are in nominal dollars (i.e., unadjusted for
                                         inflation).
                                         Compact federal services and discretionary federal programs are not included in this analysis.
                                         Funds were not provided in 2011 or 2012 to date for infrastructure projects, the infrastructure
                                         maintenance fund, or the fiscal consolidation fund.




                                         Page 11                                                                                   GAO-12-798T
Agreement Would            The Agreement would extend the authority for the provision of compact
Continue Compact Federal   federal services and discretionary programs in Palau.
Services and Extend
                               Federal services. The Agreement would amend the compact’s
Framework for                   subsidiary agreements regarding federal services. Specifically, the
Discretionary Federal           Agreement amends the terms of postal, weather, and aviation
Programs                        services to Palau.

                               Federal discretionary programs. The Agreement would extend the
                                framework for U.S. agencies to provide discretionary federal programs
                                to Palau, with implementation of the programs contingent on annual
                                appropriations to those agencies.


                           The addition of $30.25 million in U.S. contributions and the delay of $89
Agreement’s                million in Palau withdrawals through 2023, as provided by the Agreement,
Provisions Would           would improve the fund’s prospects for sustaining scheduled payments
                           through 2044. At the end of June 2012, the fund had a balance of
Significantly Improve      approximately $163 million. The trust fund would need a 5.0 percent
Prospects for Palau        annual return to yield the proposed withdrawals from 2011 through 2044
Trust Fund                 under the Agreement. This rate is well below the 7.9 percent return that
                           the fund earned from its inception to June 30, 2012.29 Figure 3 shows
                           projected trust fund balances in 2012 through 2044 under the Agreement,
                           with varying rates of return.




                           29
                             All rates of return on the trust fund are net of fees and commissions unless otherwise
                           noted.




                           Page 12                                                                       GAO-12-798T
Figure 3: Projected Palau Trust Fund Balance under the Agreement, with Varying Rates of Return, 2012-2044




                                        Notes:
                                        Years are fiscal (Oct. 1-Sept. 30), and dollar amounts are in nominal dollars (i.e., unadjusted for
                                        inflation).
                                        The analysis shown is based on the fund’s balance as of September 30, 2011, and assumes that the
                                        Agreement’s provisions related to the trust fund—including additional U.S. contributions and reduced
                                        Palau withdrawals through 2023—are approved.


                                        The additional contributions and reduced withdrawals scheduled in the
                                        Agreement would also make the trust fund a more reliable source of
                                        revenue under conditions of market volatility. With these changes, the
                                        trust fund would have an approximately 90 percent probability of
                                        sustaining payments through 2044. In comparison, the fund has a 40
                                        percent probability of sustaining the $15 million annual withdrawals
                                        scheduled under the compact through 2044.

                                        Figure 4 compares the probability that the trust fund will sustain the
                                        proposed withdrawals under the terms outlined in the Agreement with the
                                        probability that the trust fund will sustain the withdrawals scheduled under
                                        the compact.




                                        Page 13                                                                                   GAO-12-798T
Figure 4: Probability That Palau Trust Fund Will Sustain Scheduled Withdrawals under Two Scenarios




                                        Notes:
                                        Years are fiscal (Oct. 1-Sept. 30), and dollar amounts are in nominal dollars (i.e., unadjusted for
                                        inflation).
                                        This figure depicts results from 10,000 trial runs. For each run, the returns of each asset class are
                                        randomly drawn from a distribution based on the historical returns. The account balances and the
                                        withdrawal amount from the trust fund are then calculated based on the returns and the withdrawal
                                        schedule. The probability of the trust fund’s being able to disburse the scheduled amount is then
                                        generated from a distribution of 10,000 disbursements each year.
                                        The figure’s upper line shows the probability that the trust fund will sustain scheduled withdrawals
                                        under the Agreement’s provisions of (1) annual U.S. contributions of $3 million from 2013 through
                                        2022 and $250,000 in 2023 and (2) annual Palau withdrawals of $5 million in 2011, gradually
                                        increasing to $13 million in 2023, and $15 million from 2024 through 2044. The figure’s lower line
                                        shows the probability that the trust fund will sustain scheduled payments under the compact’s
                                        provision of $15 million annual withdrawals through 2044.




                                        Page 14                                                                                   GAO-12-798T
                        Estimates prepared for the government of Palau project that Palau’s
Estimates Prepared      reliance on U.S. assistance provided under the Agreement will decline,
for Palau Project       while its reliance on trust fund withdrawals and domestic revenue will
                        increase.30 These estimates show U.S. assistance, as provided under the
Declining Reliance on   Agreement, declining from 28 percent of government revenue in 2011 to
U.S. Assistance under   less than 2 percent of government revenue in 2024. The estimates also
the Agreement           show Palau’s trust fund withdrawals growing from 5 percent of
                        government revenue in 2011 to 12 percent in 2024. In addition, the
                        estimates indicate that Palau’s domestic revenue will rise from 40 percent
                        of all government revenue in 2011 to 59 percent in 2024.31 Finally, the
                        estimates prepared for Palau project a relatively steady reliance on U.S.
                        discretionary federal programs, ranging from 12 percent of all government
                        revenue in 2011 to 14 percent in 2024. The estimates assume that
                        discretionary federal programs will grow at the rate of inflation; however,
                        discretionary programs are subject to annual appropriations and may not
                        increase over time.

                        Figure 5 shows the types and amounts of Palau’s estimated revenues for
                        2011 and 2024.




                        30
                          The government of Palau provided fiscal projections through 2024 to the Senate
                        Committee on Energy and Natural Resources in January 2011. The estimates were
                        prepared by an independent economist retained by the government of Palau.
                        31
                          In March 2011, the IMF reported that Palau government revenues as a percentage of
                        GDP are below average for island nations in the Pacific. The report cited opportunities for
                        increased tax revenues by eliminating the gross revenue tax, replacing it with a corporate
                        income tax, introducing a Value Added Tax, and increasing the level of taxation on high
                        earners. The IMF also noted that Palau could reform its civil service to decrease wage
                        expenditures. IMF, “Staff Visit to Republic of Palau—Concluding Statement of the IMF
                        Mission” (Mar. 8, 2011).




                        Page 15                                                                        GAO-12-798T
Figure 5: Estimated Palau Government Revenues for 2011 and 2024




Notes:
Years are fiscal (Oct. 1-Sept. 30), and dollar amounts are in nominal dollars (i.e., unadjusted for
inflation).
The years shown were chosen to illustrate the trend in Palau’s revenues from 2011, when the terms
proposed by the Agreement would begin, through 2024, when assistance provided by the Agreement
would expire.
Federal services were not included in the estimates prepared for Palau.
“Trust fund withdrawal” includes the maximum withdrawal for 2011 and 2024 as specified in the
Agreement.
“Assistance provided by the Agreement” includes all funding specified in the Agreement.
“Discretionary federal programs” includes estimates prepared for the government of Palau for
program funding and grants from U.S. agencies in 2011 and 2024.
“Other donor assistance” includes estimates for assistance from other foreign donors for 2011 and
2024.
“Domestic revenue” includes estimates of taxes and fees to be collected by the Palau government in
2011 and 2024.




Page 16                                                                                   GAO-12-798T
Estimates Prepared for    The estimates prepared for the government of Palau project that U.S.
Palau Project             assistance to Palau from 2011 through 2024, including discretionary
Discretionary Program     federal programs, will total approximately $427 million. The estimates
                          further project that discretionary programs will account for nearly half of
Funding as Half of U.S.   U.S. assistance through 2024, with assistance amounts specified in the
Assistance                Agreement accounting for the other half. (See fig. 6.) In contrast, in 2008,
                          we estimated discretionary program funding accounted for less than one-
                          third of total U.S. assistance to Palau from 1995 through 2009.

                          Figure 6: U.S. Assistance to Palau in 2011-2024 as Estimated for Palau and as
                          Provided under the Agreement




                          Notes:
                          Years are fiscal (Oct. 1-Sept. 30), and dollar amounts are in nominal dollars (i.e., unadjusted for
                          inflation).
                          The analysis depicted is based on the estimates prepared for the government of Palau and on the
                          Agreement’s provisions. This analysis does not include federal services, which are not addressed in
                          the estimate prepared for Palau and generally are not specified in the Agreement.




                          Page 17                                                                                   GAO-12-798T
                      “Discretionary federal programs” includes all funds appropriated to federal agencies for assistance to
                      Palau. The discretionary federal program estimates prepared for the government of Palau include
                      annual adjustments for inflation, but not for population growth, from 2009 through 2024. Although the
                      Agreement does not specify funding for discretionary federal programs, it extends authority for U.S.
                      agencies to provide them in Palau subject to annual appropriations.



                      Legislation has been introduced in both the Senate and the House that
Pending Legislation   would approve and implement the September 2010 agreement between
Would Approve and     the U.S. and Palau governments.
Implement the         In February 2011, a bill was introduced in the Senate that would
Agreement             implement the Agreement, as written.32 The Senate bill would authorize
                      and appropriate funds to Interior for specified assistance. The Senate bill
                      would also extend the authority, and authorize appropriations, for the
                      provision of compact federal services in Palau. However, the proposed
                      legislation does not appropriate funds for compact federal services. As of
                      September 2012, the Senate has not acted on this bill.

                      In June 2012, a bill was introduced in the House that would approve and
                      implement the Agreement, with some modifications.33 Specifically, the
                      pending House bill:

                           Shifts the timing of the provision of some specified Agreement
                            assistance to account for the fact that fiscal year 2011 has passed.

                           Extends the full faith and credit provision of the compact34 to the U.S.
                            commitments of assistance under the Agreement for direct economic
                            assistance, the trust fund, the infrastructure maintenance fund, the
                            fiscal consolidation fund, and infrastructure projects.

                           Applies an inflation adjustment to the Agreement assistance for direct
                            economic assistance and infrastructure project grants, and payments




                      32
                          S. 343.
                      33
                          H.R. 6040.
                      34
                        Pursuant to this compact provision, should the United States fail to provide a payment
                      covered by the pledge, Palau would be able to seek relief in the U.S. Claims Court or its
                      successor court.




                      Page 18                                                                                 GAO-12-798T
       to the trust fund, infrastructure maintenance fund, and fiscal
       consolidation fund.35

      Extends a pledge of the full faith and credit of the United States for the
       full payment of the amounts necessary to conduct the audits of the
       assistance provided, as called for under the Agreement.36

In addition, the Senate and House bills implementing the Agreement
would amend the sections of the Agreement that extend the authority for
the provision of compact federal services and discretionary programs in
Palau. The proposed Senate and House legislation would authorize
annual appropriations for weather and aviation services.37 The proposed
Senate and House legislation would extend the eligibility of the people,
government, and institutions of Palau for certain discretionary programs,
including special education and Pell grants.38 However, the proposed bills
differ in how they would authorize appropriations to subsidize postal
service to Palau, the Republic of the Marshall Islands, and the Federated
States of Micronesia. The Senate legislation would have authorized
appropriations of $1.5 million to Interior for 2011 through 2024, to
subsidize postal services provided by the U.S. Postal Service.39 The
proposed House legislation would authorize appropriations of $1.5 million
to Interior beginning in 2012 and through 2024, to subsidize postal
services. Under the proposed House bill, Interior would be authorized to
transfer these funds to the U.S. Postal Service under the condition that
domestic postage may be used for mail to these countries.40




35
  Adjusting direct economic assistance, infrastructure project grants, and payments to the
trust fund, infrastructure maintenance fund, and fiscal consolidation fund for inflation would
increase the value of U.S. assistance to Palau. Our analysis shows that adjusting for
inflation and reducing fiscal consolidation fund as outlined in H.R. 6040, the value of U.S.
contributions would increase approximately $12 million.
36
 Under the Agreement, the government of Palau is to bear the cost of these audits.
According to an Interior official, the cost of the audits is approximately $500,000 per year.
37
    S. 343 as introduced in the Senate and H.R. 6040 as introduced in the House.
38
    Ibid.
39
    S. 343.
40
    H.R. 6040.




Page 19                                                                          GAO-12-798T
                  Chairman Fleming, Ranking Member Sablan, and Members of the
                  Subcommittee, this completes my prepared statement. I would be happy
                  to respond to any questions you may have at this time.


                  For further information about this statement, please contact David
GAO Contact and   Gootnick at (202) 512-3149 or gootnickd@gao.gov. Contact points for our
Staff             Offices of Congressional Relations and Public Affairs may be found on
                  the last page of this statement.
Acknowledgments
                  Emil Friberg (Assistant Director), Ming Chen, David Dayton, Brian
                  Hackney, Reid Lowe, Grace Lui, and Valérie L. Nowak made key
                  contributions to this statement. Robert Alarapon, Benjamin Bolitzer,
                  Rhonda Horried, Farahnaaz Khakoo, Jeremy Sebest, Cynthia Taylor, and
                  Anu Mittal provided technical assistance.




                  Page 20                                                      GAO-12-798T
                                                           Appendix I: U.S. Assistance to Palau Provided
Appendix I: U.S. Assistance to Palau                       Under the Compact and Outlined in the
                                                           Agreement


Provided Under the Compact and Outlined in
the Agreement
                                                           Table 2 shows the assistance provided to Palau under the compact from
                                                           1995 through 2009. Table 3 shows the proposed assistance to Palau for
                                                           2011 through 2024, as outlined in the Agreement.

Table 2: Compact Assistance Provided to Palau in 1995-2009

Dollars in millions
Types of
assistance             1995      1996       1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008                                                                   2009     Total
Direct
assistance            $126.5 $23.5          $22.4 $21.2 $13.6 $13.6 $13.8 $13.9 $14.1 $14.1 $12.7 $12.8 $12.9 $13.0 $13.1 $341.1
Infrastructure          53.0           0     96.0       0           0          0          0         0          0            0       0          0         0          0        0    149.0
Trust fund
contributions           66.0           0      4.0       0           0          0          0         0          0            0       0          0         0          0        0      70.0
Total                 $245.5 $23.5 $122.4 $21.2 $13.6 $13.6 $13.8 $13.9 $14.1 $14.1 $12.7 $12.8 $12.9 $13.0 $13.1 $560.1
                                                           Source: GAO analysis of the Interior OIA Budget Justifications and Performance Information fiscal year 2012.

                                                           Note: Years are fiscal (Oct. 1-Sept. 30), and dollar amounts are in nominal dollars (i.e., unadjusted for
                                                           inflation).



Table 3: Proposed Assistance to Palau as Outlined in the Agreement

Dollars in millions
Types of
assistance            2011      2012       2013     2014         2015        2016         2017          2018       2019          2020     2021      2022       2023       2024      Total
Trust fund
contributions           $0        $0       $3.00    $3.00       $3.00       $3.00        $3.00       $3.00         $3.00         $3.00   $3.00     $3.00      $0.25         $0     $30.25
Infrastructure
maintenance
fund                  2.00       2.00       2.00     2.00         2.00        2.00         2.00         2.00        2.00          2.00     2.00      2.00       2.00       2.00     28.00
Infrastructure
project
grants                8.00       8.00       8.00     6.00         5.00        5.00             0           0            0           0          0         0         0         0      40.00
Fiscal
consolidation
fund                  5.00       5.00         0        0              0            0           0           0            0           0          0         0          0        0      10.00
Direct
economic
assistance        13.00         12.75      12.50    12.00       11.50       10.00          8.50         7.25        6.00          5.00     4.00      3.00       2.00         0     107.50
Total            $28.00        $27.75 $25.50 $23.00           $21.50       $20.00      $13.50       $12.25      $11.00          $10.00   $9.00     $8.00      $4.25       $2.00   $215.75
                                                           Source: GAO analysis of the Agreement between the U.S. government and the government of the Republic of Palau following the
                                                           Compact of Free Association Section 432 review.


                                                           Note: Years are fiscal (Oct. 1-Sept. 30), and dollar amounts are in nominal dollars (i.e., unadjusted for
                                                           inflation).




                                                           Page 21                                                                                                          GAO-12-798T
                                          Appendix II: U.S. Discretionary Program Funds
Appendix II: U.S. Discretionary Program   Expended in 2009



Funds Expended in 2009

                                          Table 4 lists discretionary U.S. federal program funds expended by the
                                          Palau national government, the Palau Community College, and the Palau
                                          Community Action Agency, as reported in the organizations’ single audit
                                          reports for 2009.

Table 4: U.S. Federal Program Expenditure in Palau as Reported in 2009 Single Audit Reports

U.S. agency         Federal program                                                                   2009 expenditure
Agriculture         Cooperative Forestry Assistance                                                          $155,422
Agriculture         Community Facilities Loans and Grants                                                     124,745
Agriculture         Unknown                                                                                      1,604
Commerce            Special Oceanic and Atmospheric Projects                                                  306,485
Commerce            Unallied Management Projects                                                                    1
Education           Pell Grant                                                                               2,250,348
Education           Freely Associated States-Education Grant Program                                         1,309,324
Education           Special Education-Grants to States                                                        859,119
Education           Upward Bound Program                                                                      315,164
Education           Talent Search                                                                             204,406
Education           Upward Bound Math and Science                                                             198,998
Education          Gaining Early Awareness and Readiness for Undergraduate Programs                           198,205
Education           Student Support Services Program                                                          189,771
Education           Special Education-Grants to States                                                        122,755
Education           Federal Work-Study                                                                        109,923
Education          Academic Competitiveness Grant                                                              78,346
Education           Supplemental Educational Opportunity Grant                                                 52,600
Education           Byrd Honors Scholarships                                                                   46,500
Education           Adult Education-State Grant Program                                                        29,038
HHS                 Head Start                                                                               1,670,508
HHS                 CDC and Prevention-Investigations & Technical Assistance                                  976,068
HHS                 Consolidated Health Centers                                                               564,525
HHS                 Substance Abuse and Mental Health Services-Projects of Regional and National              431,171
                    Significance
HHS                 National Bioterrorism Hospital Preparedness Program                                       387,003
HHS                 Public Health Emergency Preparedness                                                      343,717
HHS                 Epidemiologic Research Studies of AIDS and HIV Infection in Selected Population           260,367
                    Groups
HHS                 Material and Child Health Federal Consolidated Programs                                   201,257
HHS                 Family Planning-Services                                                                  171,235
HHS                 Maternal and Child Health Services Block Grant to the States                              149,718




                                          Page 22                                                          GAO-12-798T
                                         Appendix II: U.S. Discretionary Program Funds
                                         Expended in 2009




U.S. agency      Federal program                                                                                                              2009 expenditure
HHS              Project Grants and Cooperative Agreements for Tuberculosis Control Programs                                                                 116,313
HHS              Immunization Grants                                                                                                                         113,372
HHS              Block Grants for Prevention and Treatment of Substance Abuse                                                                                111,340
HHS              Universal Newborn Hearing Screening                                                                                                           95,591
HHS              DEH-PHCI                                                                                                                                      72,266
HHS              Cooperative Agreements to Support Comprehensive School Health Programs to                                                                     67,785
                 Prevent the Spread of HIV and Other Important Health Problems
HHS              Basic/Core Area Health and Education Center                                                                                                   62,506
HHS              Block Grants for Community Mental Health Services                                                                                             58,245
HHS              Consolidated Knowledge Development and Application (KD&A) Program                                                                             55,430
HHS              Preventive Health Services - STD Control Grants                                                                                               48,079
HHS              Cooperative Agreements for State-Based Diabetes Control Programs and Evaluation                                                               44,845
                 and Surveillance Systems
HHS              HIV Care Grants                                                                                                                               38,249
HHS              ARRA-Grants to Health Center Programs                                                                                                         20,990
HHS              HIV/Aids Surveillance                                                                                                                         19,372
HHS              Preventive Health and Health Services Block Grant                                                                                             17,375
HHS              Drug Free Communities Support Program Grants                                                                                                  12,759
HHS              Civil Rights and Privacy Rule Compliance Activities                                                                                           12,620
Interior         Social, Economic and Political Development of the Territories                                                                               628,346
Interior         Historical Preservation-Grants in Aid                                                                                                       254,436
Justice          Juvenile Justice and Delinquency Prevention-Allocation to States                                                                                      1
Labor            ARRA WIA Dislocated Workers Program                                                                                                         128,027
Labor            WIA Dislocated Workers Program                                                                                                              118,574
Labor            ARRA WIA Youth Activities                                                                                                                     81,112
Labor            WIA Adult Program                                                                                                                             63,241
Labor            WIA Youth Activities                                                                                                                          62,637
Labor            ARRA WIA Adult Program                                                                                                                        49,162
Transportation   Airport Improvement Program                                                                                                            $4,309,960
Total                                                                                                                                                  $18,370,956
                                         Source: GAO analysis of Republic of Palau National Government Independent Auditor’s Reports on Internal Control and on Compliance
                                         Year Ended September 30, 2009; Palau Community College Comprehensive Annual Financial Report Fiscal Year Ended September
                                         30, 2009; and Palau Community Action Agency Report on the Audit of Financial Statements in Accordance with OMB Circular A-133
                                         Year Ended September 30, 2009.

                                         Notes:
                                         Year is fiscal (Oct. 1-Sept. 30), and dollar amounts are in nominal dollars (i.e., unadjusted for
                                         inflation).
                                         HHS = Department of Health and Human Services.




(320917)
                                         Page 23                                                                                                       GAO-12-798T
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