Summary

Since 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.