In the Wacker process, palladium acetate complexes catalyze the homogeneous reaction of ethylene and water to form acetaldehyde. We have studied the mechanism of this reaction in detail, using density functional theory computational methods. The putative most active catalyst is a dimer complex, which has been modeled by clusters of two palladium ions coordinated by acetate ligands. The active site is formed by one of the palladium ions. In the Wacker process as catalyzed by palladium acetate, ethylene coordinates to palladium. Next, coupling with hydroxyl species from the solution takes place in an outer-sphere mechanism. A series of hydrogen transfers, in which terminal acetate participates, converts the hydroxyethyl ligand into acetaldehyde. Finally, the product desorbs. The overall reaction enthalpy is exothermic. One of the hydrogen transfers, the step that results in acetaldehyde formation, is the rate-determining step. This step costs 61 kJ/mol. All reactions presumably take place within the coordination sphere, and thus hydrogen from the solvent is not incorporated into the product. Solvent effects are explicitly taken into account in all steps.