Almost all of Vatican City's 458 citizens live inside the Vatican's walls. The Vatican includes high dignitaries, priests, nuns, and guards as well as approximately 3,000 lay workers who comprise the majority of the workers.
The Holy See's diplomatic history began in the 4th century, but the boundaries of the papacy's temporal power have shifted over the centuries. In the middle of the 19th century, the Popes held sway over the Papal States, including a broad band of territory across central Italy. In 1860, after prolonged civil and regional unrest, Victor Immanuel's army seized the Papal States, leaving only Rome and surrounding coastal regions under papal control.
In 1871, Victor captured Rome itself. The following year Victor Emmanuel entered the city and declared it the new capital of Italy, ending papal claims to temporal power. Pope Pius and his successors disputed the legitimacy of these acts and proclaimed themselves to be "prisoners" in the Vatican. Finally, in 1929, the Italian Government and the Holy See signed three agreements resolving the dispute:
A treaty recognizing the independence and sovereignty of the Holy See and creating the State of the Vatican City;
A concordat defining the relations between the government and the church within Italy; and
A financial convention providing the Holy See with compensation for its losses in 1870.
A revised concordat, altering the terms of church-state relations, was signed in 1984.
source: State Department Background Notes 1998