Compact of Free Association
U.S. Assistance to Palau, Accountability Over Assistance Provided, and Palau's Prospects For Economic Self-Sufficiency Gao ID: GAO-08-858T June 12, 2008Since 1995, when the Compact of Free Association between Palau and the United States entered into force, U.S. aid to Palau has included assistance provided for in the compact and related subsidiary agreements--direct assistance to the Palau national government, including investment in a trust fund intended to provide $15 million annually from 2010 through 2044; federal postal, weather, and aviation services; and construction of a major road--with the U.S. interest of promoting Palau's self-sufficiency and economic advancement. U.S. assistance to Palau has also included discretionary federal programs, such as health, education, and infrastructure services, that are not provided for in the compact. Compact direct assistance is scheduled to expire on September 30, 2009. In addition, the related subsidiary agreement providing for federal services to Palau will expire on that date unless renewed or extended. At that time, Palau's annual withdrawals from its trust fund can increase from $5 million to $15 million. The compact mandates that the U.S. and Palau governments review the terms of the compact and its related agreements in 2009 and concur on any modifications to those terms. 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. To provide accountability for compact funds, the compact's related agreements require an annual audit of Palau's use of compact funds and require Palau to submit economic development plans, identifying planned expenditures of compact assistance, and annual reports on, among other topics, its implementation of these plans. The U.S. and Palau governments are also required to hold annual economic consultations to review Palau's progress toward self-sufficiency and to consult regarding Palau's trust fund every 5 years. My statement is based on our report, which was released this week. In this report, we examined (1) the provision of compact and other U.S. assistance to Palau in 1995-2009, (2) Palau's and U.S. agencies' efforts to provide accountability over Palau's use of federal funds, and (3) Palau's prospects for achieving economic self-sufficiency. We conducted this performance audit from October 2007 to June 2008 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.
U.S. aid to Palau in 1995-2009 is expected to exceed $852 million. Compact direct assistance, providing general budgetary support for Palau's government operations, is projected at $411 million, or 48 percent of the assistance provided. The provision of compact federal services--postal, weather, and aviation--is projected at about $25 million, or 3 percent of the assistance, and the compact road construction accounted for $149 million, or 17 percent of the assistance. Palau's receipt of discretionary federal program assistance is projected at $267 million, or 31 percent of the total assistance provided. In 1995-2006, five U.S. agencies--the Departments of Education (Education), Health and Human Services (HHS), Interior, Defense (DOD), and Transportation (DOT)--contributed the majority of discretionary federal program assistance to Palau. Palau has made progress in establishing financial accountability, despite limited capacity to address persistent internal control weaknesses, and has met most compact accountability requirements; however, Interior's monitoring of Palau's accountability has been limited. Palau's single audit reports for 1995-2006 show that it improved its timeliness in submitting the reports and improved the reliability of its financial statements. However, the reports show persistent weaknesses in Palau's internal controls over financial reporting; the reports also indicate that Palau has not complied with all federal award requirements and show persistent weaknesses in Palau's internal controls over compliance with these requirements. Although Palau has developed plans to correct these weaknesses, limited capacity in financial accounting resources and expertise puts at risk Palau's ability to sustain its improvements in financial accountability and to operate a major federal program within applicable requirements. Palau met the majority of the compact's and related agreements' accountability requirements, such as submitting annual reports and economic development plans. OIA and State officials, as well as officials from the government of Palau, reported that they participated in the required economic consultations but that the meetings were not held annually. Moreover, U.S. and Palau officials acknowledged that the required trust fund consultations were not held at all. According to OIA officials, OIA has used Palau's single audit results and compact annual reports to monitor Palau's use of compact funds and has provided technical assistance funds to train Palau employees as well as funds to enhance Palau's financial management systems and processes. However, OIA officials said that Interior views its oversight role as limited. To improve Palau's ability to sustain its improvements in financial reporting and address its internal control weaknesses, our report recommends that the Secretary of the Interior direct OIA to formally consult with the government of Palau regarding Palau's financial management challenges and target future technical assistance toward building Palau's financial management capacity. Responding to a draft of our report, Interior agreed with our recommendation and identified steps it will take to implement it.
GAO-08-858T, Compact of Free Association: U.S. Assistance to Palau, Accountability Over Assistance Provided, and Palau's Prospects For Economic Self-Sufficiency
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Testimony:
Before the House Committee on Natural Resources, Insular Affairs
Subcommittee U.S. House of Representatives:
United States Government Accountability Office:
GAO:
For Release on Delivery:
Expected at 11:00 a.m. EDT:
Thursday, June 12, 2008:
Compact Of Free Association:
U.S. Assistance to Palau, Accountability Over Assistance Provided, and
Palau's Prospects For Economic Self-Sufficiency:
Statement of David Gootnick:
Director: International Affairs and Trade Team:
GAO-08-858T:
June 12, 2008:
Madame Chairwoman and Members of the Subcommittee:
I am pleased to be here today to discuss compact and other U.S.
assistance to the Republic of Palau. Since 1995,[Footnote 1] when the
Compact of Free Association between Palau and the United States entered
into force, U.S. aid to Palau has included assistance provided for in
the compact and related subsidiary agreements--direct assistance to the
Palau national government, including investment in a trust fund
intended to provide $15 million annually from 2010 through 2044;
federal postal, weather, and aviation services; and construction of a
major road--with the U.S. interest of promoting Palau's self-
sufficiency and economic advancement. U.S. assistance to Palau has also
included discretionary federal programs, such as health, education, and
infrastructure services, that are not provided for in the compact.
[Footnote 2]
Compact direct assistance is scheduled to expire on September 30, 2009.
In addition, the related subsidiary agreement providing for federal
services to Palau will expire on that date unless renewed or extended.
[Footnote 3] At that time, Palau's annual withdrawals from its trust
fund can increase from $5 million to $15 million. The compact mandates
that the U.S. and Palau governments review the terms of the compact and
its related agreements in 2009 and concur on any modifications to those
terms. (See attachment I for more information on key provisions of the
compact and its related agreements.) 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.
To provide accountability for compact funds, the compact's related
agreements require an annual audit of Palau's use of compact funds and
require Palau to submit economic development plans, identifying planned
expenditures of compact assistance, and annual reports on, among other
topics, its implementation of these plans. The U.S. and Palau
governments are also required to hold annual economic consultations to
review Palau's progress toward self-sufficiency and to consult
regarding Palau's trust fund every 5 years.
My statement is based on our report, which was released this week.
[Footnote 4] In this report, we examined (1) the provision of compact
and other U.S. assistance to Palau in 1995-2009, (2) Palau's and U.S.
agencies' efforts to provide accountability over Palau's use of federal
funds, and (3) Palau's prospects for achieving economic self-
sufficiency. We conducted this performance audit from October 2007 to
June 2008 in accordance with generally accepted government auditing
standards. Those standards require that we plan and perform the audit
to obtain sufficient, appropriate evidence to provide a reasonable
basis for our findings and conclusions based on our audit objectives.
We believe that the evidence obtained provides a reasonable basis for
our findings and conclusions based on our audit objectives.
Summary:
U.S. aid to Palau in 1995-2009 is expected to exceed $852 million.
Compact direct assistance, providing general budgetary support for
Palau's government operations, is projected at $411 million, or 48
percent of the assistance provided.[Footnote 5] The provision of
compact federal services--postal, weather, and aviation--is projected
at about $25 million, or 3 percent of the assistance, and the compact
road construction accounted for $149 million, or 17 percent of the
assistance. Palau's receipt of discretionary federal program assistance
is projected at $267 million, or 31 percent of the total assistance
provided. In 1995-2006, five U.S. agencies--the Departments of
Education (Education), Health and Human Services (HHS), Interior,
Defense (DOD), and Transportation (DOT)--contributed the majority of
discretionary federal program assistance to Palau.
Palau has made progress in establishing financial accountability,
despite limited capacity to address persistent internal control
weaknesses, and has met most compact accountability requirements;
however, Interior's monitoring of Palau's accountability has been
limited. Palau's single audit reports for 1995-2006 show that it
improved its timeliness in submitting the reports and improved the
reliability of its financial statements. However, the reports show
persistent weaknesses in Palau's internal controls over financial
reporting; the reports also indicate that Palau has not complied with
all federal award requirements and show persistent weaknesses in
Palau's internal controls over compliance with these requirements.
Although Palau has developed plans to correct these weaknesses, limited
capacity in financial accounting resources and expertise puts at risk
Palau's ability to sustain its improvements in financial accountability
and to operate a major federal program within applicable requirements.
Palau met the majority of the compact's and related agreements'
accountability requirements, such as submitting annual reports and
economic development plans. OIA and State officials, as well as
officials from the government of Palau, reported that they participated
in the required economic consultations but that the meetings were not
held annually. Moreover, U.S. and Palau officials acknowledged that the
required trust fund consultations were not held at all. According to
OIA officials, OIA has used Palau's single audit results and compact
annual reports to monitor Palau's use of compact funds and has provided
technical assistance funds to train Palau employees as well as funds to
enhance Palau's financial management systems and processes. However,
OIA officials said that Interior views its oversight role as limited.
Palau's prospects for economic self-sufficiency depend on four key
factors: levels of continued U.S. assistance, the availability and
value of trust fund withdrawals, fiscal reform to reduce Palau's
dependence on these withdrawals, and private sector growth through an
improved business environment.
* U.S. assistance. Given the $10 million scheduled increase in Palau's
annual trust fund withdrawals in 2010, the expiration of $13.3 million
in U.S. compact direct assistance at the end of 2009 will likely cause
a net decline of less than 4 percent in Palau's national government
revenues. However, potential increases or reductions in future levels
of discretionary federal programs--estimated at $11.9 million in 2009-
-could have a significant fiscal impact. In addition, unless the
federal programs and services agreement is extended by the U.S. and
Palau governments, Palau will lose postal, weather, and aviation
services projected to cost U.S. agencies almost $1.6 million in 2009.
* Trust fund withdrawals. A compounded annual return of at least 8.1
percent will allow Palau to withdraw $15 million per year from its
trust fund for the planned 35 years. From 1995 through March 2008, the
Palau trust fund earned a compounded return of 9 percent.[Footnote 6]
However, market volatility makes it possible that the trust fund will
be depleted after 2016 even with a favorable long-term average rate of
earnings. In addition, inflation will cause the withdrawals to lose
value over time.
* Fiscal reform. To decrease its long-term reliance on trust fund
financing, Palau will require fiscal reforms aimed at closing the gap
between its revenues and expenditures. Specifically, experts suggest
that Palau increase its tax income by addressing the problem of weak
tax administration and reduce its expenditures by lowering the public
sector wage bill.
* Private sector growth. To promote private sector growth, Palau will
need to improve its business environment. Currently, restrictive
foreign investment regulations and practices, deficient financial
oversight, inadequate access to land, and an inability to attract
skilled workers raise private sector costs and weaken investment
incentives.
To improve Palau's ability to sustain its improvements in financial
reporting and address its internal control weaknesses, our report
recommends that the Secretary of the Interior direct OIA to formally
consult with the government of Palau regarding Palau's financial
management challenges and target future technical assistance toward
building Palau's financial management capacity. Responding to a draft
of our report, Interior agreed with our recommendation and identified
steps it will take to implement it.
Background:
Palau's territory of about 190 square miles includes 8 main islands and
more than 250 smaller islands. As the westernmost cluster of the
Caroline Islands in the North Pacific Ocean, Palau is located
approximately 500 miles southeast of the Philippines. Roughly 20,000
people live in Palau, and more than one-quarter of the population is
non-Palauan.
Palau's economy is heavily dependent on its tourism sector and on
foreign aid from the United States, Japan, and Taiwan. Since 1994,
Palau's economy has grown at a real annual average of 3 percent.
[Footnote 7] In 2006, Palau's gross domestic product (GDP) was about
$154 million and its GDP per capita was about $7,500. International
visitor arrivals--more than 82,000 in 2006--contributed about $97
million to the economy. Similar to many small island economies, Palau
also receives significant foreign aid, which finances a large public
sector.
In 2006, Palau's national government expenditures were approximately
$89 million, equivalent to 58 percent of its GDP, and the United States
and other donors provided grants totaling about $44 million, equivalent
to 28 percent of Palau's GDP (see attachment II). Palau's national
government employed about one-third of all workers in 2006, and the
government's wage bill constituted 37 percent of its total
expenditures.[Footnote 8] The national government's 2006 expenditures
exceeded its total revenues; however, Palau has access to financing
through interest earned on government assets and to annual withdrawals
on the compact-provided trust fund. Palau's private sector relies
heavily on foreign workers, mostly from the Philippines; since 1994,
foreign workers have grown to account for half of Palau's total labor
force.[Footnote 9]
U.S. Assistance to Palau Is Projected to Exceed $852 Million in 1995-
2009:
The United States' cost of providing assistance to Palau in 1995-2009
is projected to exceed $852 million. The three categories of assistance
mandated by the compact--compact direct assistance, compact federal
services, and compact road construction--represent approximately 48
percent, 3 percent, and 17 percent, respectively, of total projected
U.S. assistance for 1995-2009. U.S. agencies provide the remaining 31
percent of total assistance through discretionary federal programs.
(See attachment III.)
* Compact direct assistance. Compact direct assistance accounts for
roughly half of projected U.S. assistance to Palau in 1995-2009,
amounting to more than $411 million. This assistance flows as a direct
transfer payment to the government of Palau. The compact specifies
general purposes for these funds--for example, current account
operations and maintenance, energy production self-sufficiency,
maritime zone surveillance and enforcement, and initial funding of the
trust fund--but gives the Palau government broad discretion regarding
their use.[Footnote 10] Some direct assistance is provided annually for
15 years from the effective date of the compact (i.e., 1995-2009).
However, more than half of the direct assistance was provided in the
first 3 years of the compact, allowing Palau to invest some of these
funds to generate additional income. All compact direct assistance will
terminate in 2009. (See attachment IV.)
* Compact federal services. The compact provides for federal postal,
weather, and aviation services in Palau at a level equivalent to the
services provided the year before the compact was implemented. In 1995-
2009, U.S. agencies provided compact federal services at a total cost
of approximately $25.3 million: the U.S. Postal Service spent about
$12.3 million, the National Weather Service spent about $8.6 million,
and the Federal Aviation Administration spent about $4.4 million.
* Compact road. The compact required the United States to build a road
system in Palau, based on specifications mutually agreed upon with the
government of Palau, which was to be completed by October 1, 2000. The
road project incurred several planning and construction delays and was
completed on October 1, 2007, at a cost of approximately $149 million.
When the road was completed, Palau accepted responsibility for its
operation and maintenance. Palau has since made efforts to maintain the
road; however, both U.S. and Palau officials expressed concerns
regarding Palau's ability to maintain the road in a condition that will
allow for the desired economic development.
* Discretionary federal programs. Discretionary federal programs are
projected to contribute approximately $266.7 million, or almost a third
of U.S. assistance to Palau in 1995-2009. In 1995-2006, more than 14
U.S. agencies provided approximately $203 million in federal grants and
other in-kind services to assist in areas such as education, health,
infrastructure improvement, and telecommunications.[Footnote 11] Five
agencies--Education, HHS, Interior, DOD, and DOT--contributed the
majority of this assistance (see attachment V). Most grants went to the
Palau national government; the Palau Community College and the Palau
Community Action Agency, a nonprofit organization, also received
grants.
Palau Made Progress in Accountability but Has Limited Capacity to
Address Internal Control Weaknesses, and Interior's Oversight Has Been
Limited:
Although Palau's more recent single audit reports show improvement in
its financial accountability, the reports show persistent weaknesses in
its internal control over financial reporting, its compliance with some
federal award requirements, and its internal control over compliance
with these requirements. However, Palau has limited capacity to address
these weaknesses in a timely way, putting Palau at risk of being unable
to sustain its improvements in financial accountability and to operate
a major federal program according to applicable requirements. Palau met
the majority of the compact's and related agreements' reporting
requirements for accountability over compact funds, but Palau and the
U.S. government did not meet all of the consultation requirements.
Interior's oversight of Palau's accountability for compact assistance
was limited.
Palau's timeliness in submitting single audit reports has improved in
recent years. Although Palau submitted its single audit reports for
1998-2004 after the established deadlines, Palau submitted reports for
2005 and 2006 on time. Timely submission of single audit reports gives
U.S. agencies current knowledge of the Palau government's ability to
account for federal grant monies received and current knowledge of the
government's internal control and compliance challenges.
In addition, the recent single audits show that the reliability of
Palau's financial statements has improved. For 1995-2002, Palau
received qualified audit opinions on its government's financial
statements, indicating that significant issues prevented the auditor
from concluding that the financial statements were reliable overall.
[Footnote 12] For 2003-2006, Palau's financial statements consistently
received unqualified audit opinions, indicating that the auditor
considered the statements reliable.
However, despite the improved reliability of its financial statements,
Palau has long-standing and significant weaknesses in its internal
control over financial reporting and has limited capacity to address
these weaknesses. Palau's 2006 single audit report cited a number of
significant weaknesses in basic internal control that impact its
financial reporting, many of which were cited in previous audit
reports. Palau has developed corrective action plans to address these
weaknesses and is also updating its financial reporting policies and
procedures. However, according to Palau's controller and Palau's
current external auditor, Palau has inadequate staff and expertise to
properly address its financial reporting weaknesses and make other
necessary improvements in a timely manner. As a result, Palau is at
risk of being unable to sustain its improvements in financial
accountability.
Further, Palau has limited capacity to address weaknesses in its
compliance with federal award requirements. Since 1995, Palau's single
audit reports have consistently contained qualified opinions on its
compliance with federal award requirements, owing to long-standing and
significant internal control weaknesses over its compliance with such
requirements.[Footnote 13] These weaknesses could adversely affect
Palau's ability to operate a major federal program within the
applicable requirements of laws, regulations, contracts, and grants.
Palau has developed corrective action plans to address the 2006 single
audit findings regarding its compliance with, as well as its internal
control over compliance with, federal grant requirements. However,
Palau's limited staff and expertise hinder its ability to address the
single audit report's findings in a timely manner.
Regarding compliance with the compact and its related agreements, Palau
met the majority of the reporting requirements, submitting the required
economic development plans and annual reports. Palau and U.S. officials
reported holding the required economic consultations but in most cases
did not document their compliance. However, according to Palau and U.S.
officials, the required trust fund consultations did not take place.
Interior provided limited oversight of Palau's accountability for
compact and other U.S. assistance. Interior's OIA and Office of
Inspector General (OIG) reported efforts to assist or oversee Palau's
accountability for federal funds. For example, according to Interior
officials, Interior has monitored Palau's progress in completing and
issuing its single audit reports; used Palau's single audit and compact
annual reports to monitor Palau's use of compact funds; and worked with
Palau to track single audit findings and resolve issues. Also,
according to Interior officials, OIA has provided general technical
assistance funds to train Palau employees as well as funds to enhance
Palau's financial management systems and processes. However, an OIA
official said that its oversight of compact funding has not been
extensive and that the compact gives Palau broad discretion in compact
spending. Moreover, in a 2006 memorandum, Interior's OIG criticized OIA
for its minimal oversight and monitoring of Palau's compact funding.
Although the memorandum did not contain recommendations, it suggested
that OIA commit additional resources, such as a full-time staff member,
to oversee accountability for compact funds and any other U.S.
assistance provided to Palau.
Palau's Prospects for Economic Self-sufficiency Depend on Multiple
Factors:
Palau's prospects for achieving long-term economic self-sufficiency
depend on at least four factors: levels of continuing U.S. assistance,
the availability and value of trust fund withdrawals, fiscal reform to
reduce Palau's long-term dependence on these withdrawals, and private
sector growth through an improved business environment.
Levels of U.S. Assistance:
Palau's prospects for economic self-sufficiency depend in part on
levels of continuing discretionary federal program assistance and
compact federal services. We estimate that in 2009, the Palau national
government's potential revenues--compact direct assistance,
discretionary federal programs, other donor assistance, and domestic
revenues[Footnote 14]--will total about $87 million (see attachment
VI).
Although the expiration of compact direct assistance at the end of 2009
will reduce the national government's revenues by about $13.3 million,
Palau will gain access to an additional $10 million in annual financing
when its yearly trust fund withdrawals increase in 2010 from $5 million
to $15 million. As a result, the net fiscal impact of expiring compact
direct assistance will be about $3.3 million annually, or less than 4
percent of the national government's revenues in 2009.
Any changes in the levels of discretionary federal program assistance
and compact federal services after 2009 will affect Palau's fiscal
condition. Discretionary federal program assistance, which grew from
$7.3 million in 2000 to $18.8 million in 2006, is projected at $11.3
million in 2008[Footnote 15] and may total almost $12 million, or 14
percent of the national government revenues, in 2009. However, the
level of discretionary program funding after 2009 will depend on
Palau's program eligibility status and the availability of
appropriations; changes in either factor may increase or reduce the
amounts received.[Footnote 16] Absent affirmative action by Congress,
Palau's eligibility for some federal programs could expire. The
expiration of the compact's federal programs and services agreement in
2009 may also impact U.S. agencies' implementation of discretionary
federal programs in Palau, although agency officials we interviewed
expressed uncertainty about the extent of any such impact. Moreover,
unless the federal programs and services agreement is renewed or
extended past 2009, Palau will lose postal, weather, and aviation
services that are estimated to cost U.S. agencies almost $1.6 million
in 2009.
Availability and Value of Trust Fund Withdrawals:
Palau's prospects for economic self-sufficiency also depend in part on
the availability of the planned $15 million annual trust fund
withdrawals and the value of those withdrawals over time. Palau will be
able to withdraw $15 million per year from its trust fund for the
planned 35 years--from 2010 through 2044--if the fund earns a
compounded annual return of at least 8.1 percent. To grow in
perpetuity, the trust fund must earn a compounded return rate of 8.6
percent or higher. Both of these rates are lower than the 9 percent
rate the trust fund has earned from its inception in 1995 through March
2008, however, forecasts of future returns are subject to considerable
uncertainty. The historical rates of return for the asset classes held
in the fund's portfolio differ depending on the time period considered.
For example, the compounded rate of return was 8.1 percent for 1926-
2007, 9.1 percent for 1970-2007, and 5.2 percent for 1998-
2007.[Footnote 17] If the trust fund continues to earn the 9 percent
annual return it has earned thus far, or any rate equal or greater than
8.6 percent, the trust fund will likely grow in perpetuity from its
balance as of March 2008 (see attachment VII).
However, market volatility adds uncertainty regarding the availability
of the trust fund withdrawals. Despite its historical compounded annual
return rate of 9 percent as of March 2008, the trust fund's annual
investment returns have ranged from 24 percent in 1998 to negative 12
percent in 2002. Future returns to the trust fund portfolio are
uncertain. Even if the trust fund earns a favorable long-run return
which could allow the fund to grow in perpetuity without market
volatility, a few consecutive years of poor stock market performance
could lead to the depletion the fund. Attachment VIII illustrates
results from our analysis with the assumption that future returns are
drawn from distributions based on the historical 1970-2007 return of
the asset classes in which Palau's trust fund is invested. Our analysis
shows that the trust fund will be able to disburse $15 million per year
through 2016 but is increasingly likely to be exhausted after 2016.
In addition, inflation will diminish the value of the annual trust fund
withdrawals: because the withdrawals are not adjusted for inflation,
they will lose real value over time. We estimate that by 2044--the last
year of planned trust fund assistance--the value of the annual
withdrawal will have decreased by about half compared with its value in
2010.[Footnote 18]
Fiscal Reform:
Palau's prospects for economic self-sufficiency depend in part on
fiscal reform to reduce Palau's long-term dependence on trust-fund
withdrawals. Government officials and International Monetary Fund (IMF)
experts have defined fiscal sustainability for Palau after 2009 as
having sufficient domestic revenues, such as tax and fee income, to pay
for operating expenditures, such as those for wages, goods, and
services.[Footnote 19] In 2000-2006, domestic revenues provided an
average of 50 percent of national government revenue, while operating
expenditures accounted for an average of 79 percent of national
government spending. Palau could seek continued donor assistance to pay
for capital expenditures; moreover, beginning in 2010, Palau will have
access to the $15 million annual trust fund withdrawals to finance the
gap between its revenues and expenditures. However, Palau's long-term
fiscal sustainability relies on reduced dependence on the full trust
fund withdrawal, given (a) the uncertainty of continued donor
assistance for capital spending, (b) the declining real value of the
annual withdrawal, and (c) the expected exhaustion of the trust fund
after 2044 as well as the risk of its earlier exhaustion due to market
volatility.
To close the gap between Palau's revenue and expenditures,
implementation of tax and expenditure reforms will be needed according
to economic experts, Palau officials, and the country's economic plans.
However, full implementation of such reforms is expected to require 10
to 15 years.
* Tax revenue. In 2006, Palau's tax revenue provided about $30 million
and was equivalent to 19 percent of GDP, a level broadly comparable to
that of other Pacific island nations. However, according to IMF and
Asian Development Bank (ADB) experts, Palau's tax system is inefficient
because of, among other problems, weak tax administration and
ineffective tax policy. For example, fewer than 50 percent of active
taxpayers are fully compliant, according to the IMF and ADB; the
government rarely collects assessed penalties and interest or exercises
its authority to suspend or revoke business licenses; and the current
system does not tax nonwage income, such as that from profits,
investment, or property, and taxes businesses on gross, rather than
net, earnings.
* Expenditures. Economic experts and government officials suggest that
Palau could lower its operating expenditures, at around $67 million in
2006, by reducing the public sector wage bill. Although Palau has
slightly reduced its nonwage operating expenditures since 2000, it has
been less successful in reducing the wage bill. From 2000 through 2006,
Palau's national government wage bill grew from 46 percent to 50
percent of its operating expenditures, with wage levels nearly twice
those in the private sector. According to government officials, Palau
instituted a freeze on public sector employment in 2001 that has not
been observed, and recent public sector reclassification efforts will
result in a further increase in wage expenditures.
Private Sector Growth:
Palau's prospects for economic self-sufficiency depend in part on the
growth of its economy through private sector expansion, which will
require an improved business environment. Palau's strategy for
expanding its private sector focuses primarily on pursuing
environmentally sustainable growth by promoting high-end tourism and
capitalizing on growth opportunities from the new compact road.
Officials, experts, and private sector representatives view the tourism
sector as offering the most potential for growth. For example, the IMF
estimates that every 2 percent increase in tourist arrivals creates a 1
percent increase in tourism-related employment and that more than a
third of foreign direct investment occurs in this sector. Current Palau
tourism strategies aim to capitalize on opportunities for high-end
tourists from Asia and from U.S. military bases on Guam. The marine and
agricultural industries together provide less than 5 percent of GDP;
however, Palau is pursuing opportunities in aquaculture and considering
whether foreign fishing license fees could be raised. In all cases,
private sector development is dependent on sustained exploitation of
Palau's fragile environmental resources.
However, according to Palau government officials, economic experts, and
private sector representatives, problems related to Palau's foreign
investment policies, financial systems, land ownership system, labor
market, and commercial conditions create a costly business environment
that discourages private sector growth. For example, Palau imposes
stringent requirements on foreign investment, restricting foreign
investment in certain activities; Palau's financial markets do not
effectively finance investment but instead supply large amounts of
consumer credit; Palau's system of land ownership prevents the
effective use of land for development; available skilled labor is
lacking in Palau and Palau government officials expressed concern about
illegal importation of unskilled foreign workers; and Palau's
commercial legal system is outdated, lacking laws for bankruptcy,
sales, and consumer privacy protection, and the government often
reportedly delays payment of vendors for several years.
Conclusions and Recommendations:
In 2009, the U.S. and Palau governments will formally review the terms
of the compact and its related agreements. Although compact direct
assistance will expire that year, the provision of federal postal,
weather, and aviation services may continue if the federal programs and
services agreement is renewed or extended. Some discretionary federal
programs will also likely continue. Interior's OIA will remain the
cognizant agency for Palau for compact direct assistance through 2009
and will continue to review Palau's single audits as long as U.S.
federal program funds are expended in Palau. However, unless Palau
strengthens its financial accounting resources and expertise, its
ability to sustain recent progress in financial accountability and to
operate a major federal program according to applicable requirements is
at risk. To strengthen Palau's ability to provide accountability and
meet applicable requirements for federal assistance, our recent report
recommends that the Secretary of the Interior direct the Office of
Insular Affairs to formally consult with the government of Palau
regarding Palau's financial management challenges and to target future
technical assistance toward building Palau's financial management
capacity. Interior agreed with our recommendation and identified steps
it will take to implement it.
Madame Chairwoman, this completes my prepared statement. I would be
happy to respond to any questions you or other Members of the
Subcommittee may have at this time.
[End of section]
Attachment I: Key Provisions of the Palau Compact of Free Association
and Related Agreements:
Compact section: Title one: Government Relations;
Description of key provision:
Sovereignty;
* Establishes Palau as a self-governing nation with the capacity to
conduct its own foreign affairs;
Immigration privileges;
* Provides Palauan citizens with certain immigration privileges, such
as the rights to work and live in the United States indefinitely and to
enter the United States without a visa or passport.
Compact section: Title two: Economic Relations;
Description of key provision:
Compact direct assistance;
* 15-year term of budgetary support for Palau, including direct
assistance for current account operations and maintenance, and for
specific needs such as energy production, capital improvement projects,
health, and education;
* Requires the United States to set up a trust fund for Palau;
* This assistance expires in 2009;
Compact road;
* Requires the United States to build a road system for Palau (the
"compact road");
Compact federal services;
* Requires the United States to make available certain federal services
and related programs to Palau, such as postal, weather, and aviation
services;
* The compact federal programs and services agreement--establishing the
legal status of programs and related services, federal agencies, U.S.
contractors, and personnel of U.S. agencies implementing both compact
federal services and discretionary federal programs in Palau--expires
in 2009;
Accountability of compact funds;
* Requires Palau to report annually on its use of compact funds;
* Requires the U.S. government, in consultation with Palau, to
implement procedures for periodic audit of all grants and other
assistance.
Compact section: Title three: Security and Defense Relations;
Description of key provision:
* Establishes that the United States has full authority and
responsibility for security and defense matters in or relating to
Palau;
* Forecloses Palau to the military of any other nation except the
United States;
* The United States may establish defense sites in Palau and has
certain military operating rights;
* Security provisions specified in the subsidiary status of force
agreement[A] are binding until 2044, 50 years from the effective date
of the compact, or until the termination of title three of the compact,
whichever is longer.
Compact section: Title four: General Provisions;
Description of key provision:
* Establishes general provisions regarding approval and effective date
of the compact, conference and dispute resolution procedures, amendment
and review requirements, and compact termination procedures.
Source: GAO analysis of the Compact of Free Association.
[A] Status of Forces Agreement Concluded Pursuant to Section 323 of the
Compact of Free Association.
[End of table]
[End of section]
Attachment II: Palau National Government Expenditures and Revenues,
2000-2006:
[See PDF for image]
This figure contains two pie-charts with associated data tables. The
following data is depicted:
2000-2006 Average Expenditure by Type:
Wage bill: 40%;
Capital: 21%;
Other Operating: 39%.
2006 Expenditure Level:
Capital:
Dollars in millions: $22.7;
Percentage of GDP: 15%.
Wage bill:
Dollars in millions: $33.2;
Percentage of GDP: 22%.
Other Operating:
Dollars in millions: $33.4;
Percentage of GDP: 22%.
Total:
2000-2006 Average Revenue by Source:
Taxes: 39%;
U.S. Assistance: 35%;
Other donor assistance: 15%;
Other domestic: 15%.
2006 Revenue Level:
U.S. Assistance:
Dollars in millions: $31.5;
Percentage of GDP: 20%.
Other donor assistance:
Dollars in millions: $12.8;
Percentage of GDP: 8%.
Taxes:
Dollars in millions: $29.4;
Percentage of GDP: 19%.
Other domestic:
Dollars in millions: $9.6;
Percentage of GDP: 6%.
Total:
Dollars in millions: $83.3;
Percentage of GDP: 54%.
Source: GAO estimates based on Palau‘s single audit reports.
Notes:
GDP = gross domestic product.
Figures and tables exclude: (a) component units, such as the Palau
Community College; (b) in-kind foreign assistance, such as compact
federal services; and (c) annual net financing, such as Palau's $5
million trust fund withdrawal from 2002-2006, to pay for the gap
between revenues and expenditures. Net financing is excluded as a
revenue source given that the trust fund was designed to provide Palau
with financing only until 2044, in addition to the market volatility
associated with investment earnings.
"Other operating" expenditures include those for goods and services and
"Other domestic" revenues include fees and charges, licenses, permits,
and other direct revenues.
All years cited are fiscal years (Oct. 1-Sept. 30). All dollar amounts
are in current (i.e., nominal) dollars.
[End of figure]
[End of section]
Attachment III: Projected U.S. Assistance to Palau, 1995-2009:
[See PDF for image]
This figure is a pie-chart depicting the following data:
(Dollars in millions):
Compact direct assistance: 48% ($411.0);
Discretionary federal programs: 31% ($266.7);
Compact road: 17% ($149.0);
Compact federal services: 3% ($25.3).
Source: GAO analysis.
[See PDF for image]
Notes:
Figure shows funding for fiscal years (Oct. 1-Sept. 30). All dollar
amounts are in current (i.e., nominal) dollars.
GAO's calculations of direct compact assistance and the compact road
are based on Interior's Office of Insular Affairs' actual and estimated
payments to Palau for 1995-2009, as reported in its budget
justification to Congress for 2009. Compact federal services are
estimates of past and future expenditures by the NWS, USPS, and the
FAA. The calculation of estimated discretionary federal programs is the
sum of U.S. agency program expenditures as reported in single audits
for 1995-2006 for the Palau national government and for 1997-2006 for
the Palau Community Action Agency and the Palau Community College. GAO
projected U.S. agency program expenditures for 2007-2009. To this, we
added an estimated cost of DOD's Civic Action Teams for 1995-2009.
Estimated and projected federal program expenditures do not include the
value of U.S. loans to Palau. For more details, see app. I.
[End of figure]
[End of section]
Attachment IV: Compact Direct Assistance to Palau, 1995-2009:
Compact section: 211(a);
Compact-mandated assistance: Current account operations and
maintenance; $12 million annually for 10 years (1995- 2004) and $11
million annually for the next 5 years (2005-2009). Beginning in 1999,
$5 million of this amount shall come from the trust fund set up in
211(f);
Amount provided 1995-2009 (projected): $120 million.
Compact section: 211(b);
Compact-mandated assistance: Energy production self-sufficiency; $2
million annually for 14 years (1995-2008);
Amount provided 1995-2009 (projected): $28 million.
Compact section: 211 (c);
Compact-mandated assistance: Communications; $150,000 annually for 15
years (1995-2009) for current account operations and maintenance of
communications systems plus a sum of $1.5 million in 1995 for acquiring
communications hardware or for another operating or capital account
activity as Palau selects;
Amount provided 1995-2009 (projected): $3.75 million.
Compact section: 211(d);
Compact-mandated assistance: Maritime zone surveillance and
enforcement, health programs, and postsecondary scholarship fund;
$631,000 annually for 15 years (1995-2009);
Amount provided 1995-2009 (projected): $9.5 million.
Compact section: 211(e);
Compact-mandated assistance: Maritime zone surveillance and enforcement
start-up activities; One-time contribution of $666,800;
Amount provided 1995-2009 (projected): $0.7 million.
Compact section: 211(f);
Compact-mandated assistance: Trust fund; $66 million in 1995 plus $4
million in 1997;
Amount provided 1995-2009 (projected): $70 million.
Compact section: 212(b);
Compact-mandated assistance: Capital account purposes; One-time
contribution of $36 million in 1995;
Amount provided 1995-2009 (projected): $36 million.
Compact section: 213;
Compact-mandated assistance: Defense use impact fund; One-time
contribution of $5.5 million in 1995;
Amount provided 1995-2009 (projected): $5.5 million.
Compact section: 215;
Compact-mandated assistance: Inflation adjustment; Yearly adjustment of
amounts provided in sections 211(a), 211(b), 211(c), and 212(b);
Amount provided 1995-2009 (projected): $98.9 million.
Compact section: 221(b) and federal programs and services agreement;
Compact-mandated assistance: Special block grants for health and
education; $2 million annually for 15 years (1995-2009), $4.3 million
in 1995, $2.9 million in 1996, and $1.5 million in 1997;
Amount provided 1995-2009 (projected): $38.7 million.
Total direct assistance:
Amount provided 1995-2009 (projected): $411 million.
Source: GAO analysis of the Compact of Free Association and OIA budget
justification 2009.
Note: All years cited are fiscal years (Oct. 1-Sept. 30). All dollar
amounts are in current (i.e., nominal) dollars.
[End of table]
[End of section]
Attachment V: U.S. Agencies' Expenditures for Discretionary Programs in
Palau, 1995-2006:
This figure is a pie-chart depicting the following data:
Top Five U.S. Agencies' Expenditures in Palau, 1995-2006:
Education: $28% ($56.2 million);
HHS: 25% ($51.6 million);
Interior: 19% ($39.1 million);
DOD: 12% ($23.8 million);
Other agencies: 10% ($19.8);
DOT: 6% ($12.9).
Source: GAO analysis.
[See PDF for image]
Notes:
Figure shows expenditures for fiscal years (Oct. 1-Sept. 30). All
dollar amounts are in current (i.e., nominal) dollars.
For all agencies, with the exception of DOD, our analysis used
expenditure information reported in the single audits from the Palau
national government, the Palau Community College, and the Palau
Community Action Agency. GAO estimated DOD's expenditures for its Civic
Action Team operating costs based on information provided by DOD
officials. This figure does not include the value of other in-kind
assistance provided by DOD or any other U.S. agency and it does not
include the value of U.S. loans extended to Palau.
[End of figure]
[End of section]
Attachment VI: Palau National Government's Potential Revenues in 2009:
[See PDF for image]
This figure is a stacked vertical bar graph depicting the following
data:
Palau National Government's Potential Revenues in 2009:
Domestic revenue: $43.6 million;
Other donor assistance: $17.8 million;
Discretionary federal programs: $11.9 million (Discretionary federal
program annual levels based on eligibility);
Compact direct assistance: $13.3 million (Compact direct assistance
expires at the end of 2009);
Total: $86.6 million.
Source: GAO analysis.
Notes:
Domestic revenue includes taxes, fees and charges, licenses and
permits, and other direct revenues and excludes net investment
earnings. Total revenues exclude revenues for component units and in-
kind assistance, such as compact federal services. In addition to
revenues, Palau will have access to financing, including a $5 million
annual trust fund withdrawal. See GAO-08-732, appendix III, for
additional information.
To estimate potential 2009 domestic revenue and the level of other
donor assistance, we reviewed Palau single audit data for 2000-2006 and
Palau budgets for 2007 and 2008 and applied the average annual growth
rate from 2000-2008.
Discretionary federal programs exclude the value of DOD's Civic Action
Team program that is provided in-kind. To estimate potential 2009
discretionary federal program levels, we reviewed Palau budget data for
2008 and assumed the same level of federal programs would be provided
in 2009, adjusted for inflation.
The 2009 level of compact direct assistance is based on U.S. agency
budget data.
Years cited are fiscal years (Oct. 1-Sept. 30). All dollar amounts are
in current (i.e., nominal) dollars.
[End of figure]
[End of section]
Attachment VII: Palau's Projected Trust Fund Account Balance with Three
Rates of Return (Dollars in millions):
[See PDF for image]
The Palau trust fund had a balance of $160.775 million as of March
2008.
This figure is a multiple line graph depicting the following data:
Fiscal year: 2008;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $173.2;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $172.4
Palau Trust Fund Balance, $8.1% (rate of return needed to sustain the
trust fund for 35 years): $171.5.
Fiscal year: 2009;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $183.7;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $180.1.
Fiscal year: 2010;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $184.7;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $179.1.
Fiscal year: 2011;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $185.9;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $177.9.
Fiscal year: 2012;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $187.1;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $176.7.
Fiscal year: 2013;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $188.5;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $175.4.
Fiscal year: 2014;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $189.9;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $173.9.
Fiscal year: 2015;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $191.6;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $172.4.
Fiscal year: 2016;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $193.3;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $170.8.
Fiscal year: 2017;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $195.2;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $170.0.
Fiscal year: 2018;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $197.3;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $167.1.
Fiscal year: 2019;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $199.6;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $164.9.
Fiscal year: 2020;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $202.1;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $162.7.
Fiscal year: 2021;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $204.8;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $160.3.
Fiscal year: 2022;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $207.7;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $157.6.
Fiscal year: 2023;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $210.9;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $154.8.
Fiscal year: 2024;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $214.4;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $151.7.
Fiscal year: 2025;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $218.3;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $148.4.
Fiscal year: 2026;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $222.4;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $144.8.
Fiscal year: 2027;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $226.9;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $140.9.
Fiscal year: 2028;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $231.9;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $136.8.
Fiscal year: 2029;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $237.3;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $132.2.
Fiscal year: 2030;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $243.2;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $127.4.
Fiscal year: 2031;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $249.6;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $122.1.
Fiscal year: 2032;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $256.6;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $116.4.
Fiscal year: 2033;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $264.2;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $110.3.
Fiscal year: 2034;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $272.5;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $103.7.
Fiscal year: 2035;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $281.6;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $96.5.
Fiscal year: 2036;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $291.4;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $88.8.
Fiscal year: 2037;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $302.2;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $80.4.
Fiscal year: 2038;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $313.9;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $71.4.
Fiscal year: 2039;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $326.7;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $61.8.
Fiscal year: 2040;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $340.6;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $51.2.
Fiscal year: 2041;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $355.8;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $39.8.
Fiscal year: 2042;
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $372.3;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $27.5.
Fiscal year:
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $390.4;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $14.3.
Fiscal year:
Palau Trust Fund Balance, 9.0% (the compound rate of return Palau trust
fund earned from inception to March 2008): $410.0;
Palau Trust Fund Balance, 8.6% (rate of return needed to grow the trust
fund in perpetuity): $181.9;
Palau Trust Fund Balance, 8.1% (rate of return needed to sustain the
trust fund for 35 years): $0.000421.
Source: GAO analysis.
Note: Years shown are fiscal years (Oct. 1-Sept. 30). All return rates
are net of fees and commissions.
[End of figure]
[End of section]
Attachment VIII: Probability That Palau Trust Fund Will Be Depleted
Given Market Volatility, 2010-2044:
[See PDF for image]
This figure is a line graph depicting the following data:
Fiscal year: 2010;
Percentage: 0.
Fiscal year: 2011;
Percentage: 0.
Fiscal year: 2012;
Percentage: 0.
Fiscal year: 2014;
Percentage: 0.
Fiscal year: 2015;
Percentage: 0.
Fiscal year: 2016;
Percentage: 0.
Fiscal year: 2017;
Percentage: 0.03%.
Fiscal year: 2018;
Percentage: 0.16%.
Fiscal year: 2019;
Percentage: 0.52%
Fiscal year: 2020;
Percentage: 1.37%.
Fiscal year: 2021;
Percentage: 2.91%.
Fiscal year: 2022;
Percentage: 4.94%.
Fiscal year: 2023;
Percentage: 7.12%.
Fiscal year: 2024;
Percentage: 9.73.
Fiscal year: 2025;
Percentage: 12.37%.
Fiscal year: 2026;
Percentage: 15.34%.
Fiscal year: 2027;
Percentage: 18.13%.
Fiscal year: 2028;
Percentage: 20.74%.
Fiscal year: 2029;
Percentage: 23.66%.
Fiscal year: 2030;
Percentage: 25.97%.
Fiscal year: 2031;
Percentage: 28.38%.
Fiscal year: 2032;
Percentage: 30.58%.
Fiscal year: 2033;
Percentage: 32.45%.
Fiscal year: 2034;
Percentage: 34.08%.
Fiscal year: 2035;
Percentage: 35.86%.
Fiscal year: 2036;
Percentage: 37.54%.
Fiscal year: 2037;
Percentage: 38.85%.
Fiscal year: 2038;
Percentage: 39.96%.
Fiscal year: 2039;
Percentage: 41.19%.
Fiscal year: 2040;
Percentage: 42.33%.
Fiscal year: 2041;
Percentage: 43.3%.
Fiscal year: 2042;
Percentage: 44.26%.
Fiscal year: 2043;
Percentage: 45.18%.
Fiscal year: 2044;
Percentage: 46%.
Source: GAO analysis.
Notes:
This chart depicts results from 10,000 trial runs. For each run, the
returns of each of the asset classes are randomly drawn from a
distribution based on the historical returns (1970-2007). The account
balances and the amount of disbursements from the trust fund are then
calculated based on the returns. The probability of not being able to
disburse $15 million is then generated from a distribution of 10,000
disbursements each year.
All years cited are fiscal years (Oct. 1-Sept. 30).
[End of figure]
[End of section]
Attachment IX: GAO Contacts and Acknowledgments:
GAO Contacts:
For further information about this statement, please contact David
Gootnick at (202) 512-3149 or gootnickd@gao.gov. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on
the last page of this statement. Staff making key contributions to this
statement were Emil Friberg, Assistant Director; Kate Brentzel; Ming
Chen; Cheryl Clark; Leslie Locke; Reid Lowe; Grace Lui; Matthew Reilly;
Kendall Schaefer; and Doris Yanger.
[End of section]
Footnotes:
[1] Unless otherwise noted, all years cited are fiscal years (Oct. 1-
Sept. 30). In addition, all dollar amounts in this report are in
current (i.e., nominal) dollars.
[2] U.S. legislation establishes Palau's eligibility for these
programs, with funding for the programs appropriated by Congress.
[3] The compact's federal programs and services agreement, which
establishes the terms under which the U.S. government provides federal
postal, weather, and aviation services to Palau, took effect in 1995
and expires in 2009 (see Federal Programs and Services Agreement
Concluded Pursuant to Article II of Title Two and Section 232 of the
Compact of Free Association).
[4] GAO, Compact of Free Association: Palau's Use of and Accountability
for U.S. Assistance and Prospects for Economic Self-Sufficiency,
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-732] (Washington,
D.C.: June 10, 2008).
[5] In this statement, "compact direct assistance" refers to the grants
enumerated in sections 211-215 and section 221(b) of the compact. For
further details about the compact direct assistance, see attachment IV
of this statement.
[6] All trust fund return rates in this report are net of fees and
commissions, unless otherwise stated.
[7] After growing strongly in the first few years of the compact,
Palau's GDP declined in 1999 and stagnated until 2003 due, in part, to
negative impact on its tourism sector from the 1999 Asian Financial
Crisis and the September 11, 2001 terrorist attacks. Growth resumed in
2004. Per capita GDP estimates include both Palauan-born citizens and
foreign workers.
[8] See [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-732] for
more information on Palau's national government finances.
[9] Data on foreign workers are from Palau's Social Security office and
exclude workers not registered with the office.
[10] Palau includes an account of its implementation of direct
assistance in the compact annual reports it submits to the U.S.
government.
[11] This amount is based, in part, on information obtained in the
single audits for 1995 through 2006. At the time of this report,
audited financial data for 2007 were not yet available; Palau's 2007
single audit report is not due until June 30, 2008. Although this
amount includes the cost to DOD of providing a Civic Action Team in
Palau, it does not include the value of other in-kind assistance
provided by DOD or other U.S. agencies and does not include the value
of U.S. loans extended to Palau.
[12] Auditors are required by the Single Audit Act and OMB Circular No.
A-133 to provide an opinion (or disclaimers of opinion, as appropriate)
as to whether financial statements are presented fairly in all material
respects in conformity with generally accepted accounting principles.
Auditors render a qualified opinion when they identify one or more
specific matters that affect the fair presentation of the financial
statements. The effect of the auditors' qualified opinion can be
significant enough to reduce the usefulness and reliability of the
financial statements.
[13] In addition to requiring auditors to assess financial statements,
the Single Audit Act and OMB Circular No. A-133 require auditors to
determine and express an opinion as to whether the auditee has complied
with laws, regulations, and the provisions of contracts or grant
agreements that may have a direct and material effect on each of its
major federal programs. When auditors identify instances of
noncompliance, they are required to report whether the noncompliance
could have a direct and material effect on a major federal program.
[14] Palau's domestic revenues include taxes, fees and charges,
licenses, permits, and other direct revenues. In-kind foreign
assistance, net investments--equal to the net change in the fair value
of investments minus investment management fees--and other net
financing are excluded owing to market volatility associated with
investment earnings and the prominent role in net financing of the
compact-provided trust fund, which was designed to provide Palau
financing only until 2044. By 2009, Palau's domestic revenues are
projected to grow to about $44 million, from approximately $30 million
in 2000, based on the annual growth rate of 4.4 percent in 2000-2006.
Other donor assistance is projected to grow to about $18 million by
2009, from about $6 million in 2000, based on its annual growth rate of
17.4 percent in 2000-2006. Palau's government will also have access to
financing through earned interest and annual withdrawals from the U.S.
trust fund and other government assets.
[15] The FAA's Airport Improvement Program grant to Palau represented
more than $9 million of this assistance in 2006; it expired in 2007.
The Airport Improvement Program's reauthorization for 2008-2011 is
currently pending before Congress. It contains language that would
continue Palau's eligibility for this program.
[16] U.S. legislation establishes Palau's eligibility for these
programs, with funding for the programs appropriated by Congress.
[17] To calculate the compounded returns, we used the annual nominal
returns published in Ibbotson Associates 2008 Yearbook. We rebalance
the portfolio annually to maintain the asset allocation of 50 percent
in U.S. large capital funds, 15 percent in U.S. small capital funds,
and 35 percent in fixed income assets.
[18] We used the inflation rate projected by the Congressional Budget
Office, which is lower than the historical inflation rate (1970-2007).
A higher inflation rate will lead to further decline in value.
[19] See IMF, Republic of Palau: 2005 Article IV Consultation - Staff
Report (Washington, D.C., March, 2006). [hyperlink,
http://www.imf.org/external/pubs/cat/longres.cfm?sk=19023.0]. The IMF's
analysis of Palau's fiscal sustainability prospects recognizes that
Palau will undergo a period of adjustment after compact direct
assistance expires at the end of 2009 while pursuing economic reforms
they suggest for implementation over a 10-to 15-year period.
[End of section]
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