Before Italy was unified, it was made up of several mostly independent states – the Papal States were a large chunk of Italy, and were actually controlled by the Pope from Rome. Italy as we think of it today just wasn’t a thing for most of its history. In the 1800’s, many of those states decided to unify, becoming more-or-less what we think of as “Italy” today, but the Pope didn’t like the idea of losing power – there’s a lot more to that story, but at the end of the day, the new “Kingdom of Italy” took over the Papal states and most of Rome – they just left the Pope a little section on Vatican hill, where he called himself a “prisoner.”
The new Italian army didn’t want to take over that last section and risk the rest of Europe (or at least, all of their Catholics) declaring war on them, so they mostly left the next few Popes go about their business, but there was still a lot of political tension there. Italy considered the Vatican (and the Pope) to be Italian, but they gave the Pope a lot of special powers, while the Popes (there were several new ones elected throughout this period) considered themselves prisoners of an illegitimate government that stole all of their land.
Eventually, in 1929 with the Lateran Treaty, they came to an agreement. Vatican City was allowed to become its own independent state, Italy paid them back for the land that they “stole” in the unification, and some other agreements between Italy and the Church. So since then, Vatican City has been its own independent enclave, run by the Holy See, the Pope and the many other people that are appointed to run the church and the city.
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