The islands of Palau were originally settled by people from neighboring Pacific islands. In the 16th century, Spain claimed the islands, although Germany was allowed trading rights. With the decline of Spanish influence, the islands came under German control. The Germans established Palau as a protectorate. At the outbreak of World War I, the Japanese took over the islands and administered them under a United Nations (UN) mandate. This was a period of considerable development, with the creation of schools, hospitals, and a change in land tenure that allowed private land rights. By the end of their administration period, the Japanese in Palau numbered 26,000, outnumbering the local inhabitants. During World War II, the United States clashed with the occupying Japanese, and the United States established control of the islands in 1944. From 1947, the United States administered Palau as Trustees for the United Nations. Talk of self-determination for Palau began in 1965. In 1979, Palau approved a constitution, and in 1981 became the Republic of Palau, although not fully independent of the United States. Efforts to have approval for a Compact of Free Association with the United States (which would allow the United States to provide defense and contribute financial support) were continually thwarted by an inability to have the proposals approved by 75 percent of the vote in a referendum. After changing the constitution to allow approval by simple majority, the compact was approved in 1993, and Palau became fully independent in 1994.
The Palau government is a democracy modeled on the United States. Although the country has a long history of traditional tribal rule, democracy has been accepted and any citizen is eligible for high office. The 1979 constitution established a parliamentary government, with 2 houses. The Senate (Oibiil Era Kelulau) has 14 seats, and members are elected for 4-year terms by popular vote. The House of Delegates has 16 members, one for each state, and members are elected by popular vote, also for 4-year terms. Parliamentary candidates contest elections on the basis of their personalities and platforms; there are no party affiliations. There is a president and vice-president. There are 3 levels of court, headed by a Supreme Court, supported by a National Court, and Courts of Common Pleas.
Palau has been successful at blending its traditional heritage with its new democratic government, and that resulting government has helped to mix Palau's traditional economy with its new, more market-oriented one. Land ownership is one example of Palau's success at blending traditional practices with its new economy. As with many Pacific island nations, Palau has a long history of sharing income and land within a clan and community. Market economies are based on private ownership of land. The Palau government has taken legislative steps to accommodate the traditional sharing of lands with the free market economy by designing laws that provide guidelines for issuing land titles on land traditionally held by a family or clan.
In the year 1997-98, that government revenue (including grants) was anticipated in the budget as 57 percent of GDP. Of this, 59 percent was raised by government tax and other non-tax income, and 41 percent was grants from the United States. Income tax raised 11 percent of government revenues (excluding grants), import duties 10 percent, gross revenue tax on business 14 percent, other taxes 8 percent, and non-tax revenue (licenses, fees, trust fund income, investment income) 56 percent.
Total spending in 1997-98 was projected at 50 percent of GDP. General administration makes up 57 percent of total government spending, education 14 percent, health 14 percent, and capital expenditures 15 percent. A budgetary surplus of 6 percent of GDP was realized. The budget has been in overall surplus from 1992 to 1998, although the annual outcome has varied between a 119 percent surplus in 1994-95 (as a result of a substantial grant from the United States on the final acceptance of the Compact agreement), and a projected deficit of 18 percent in 1997-98.
The main tax rates are: 6 percent on incomes from employment, rising to 12 percent; 4 percent on the gross revenues of businesses; 4 percent on the net incomes of financial institutions; import duties varying between 3 percent (most goods) to 150 percent (tobacco); hotel room tax (10 percent); departure tax ($20); and road tax ($50 to $150).