Objective. To examine changes in postacute care (PAC) use during the initial Medicare payment reforms enacted by the Balanced Budget Act of 1997. Data Sources. We used claims data from the 5 percent Medicare beneficiary sample in 1996, 1998, and 2000. Linked data from the Denominator file, Provider of Service file, and Area Resource File provided additional patient, hospital, and market-area characteristics. Study Design. Six disease groups with high PAC use were selected for analysis. We used multinomial logit regression to examine how PAC use differed by year of service, controlling for patient, hospital, and market-area characteristics. Principal Findings. There were major changes in PAC use, and a portion of services shifted to settings where reimbursement remained cost-based. During the first reform, the home health agency interim payment system, home health use decreased consistently across disease groups. This decrease was accompanied by increased use in skilled nursing facilities (SNFs). Following the implementation of the prospective payment system for SNFs, the use of inpatient rehabilitation facilities increased. Conclusions. The shift in usage among settings occurred in two stages that corresponded to the timing of payment reforms for home health agencies and SNFs. Evidence strongly suggests the substitutability between PAC settings. Financial incentives, in addition to clinical needs and individual preferences, play a major role in PAC use.Key Words. Postacute care, skilled nursing facility, rehabilitation, home health care, Balanced Budget Act Medicare postacute care (PAC) services provide recuperative or rehabilitative services to patients discharged from acute-care hospitals. As hospital length of stays shortened considerably after the hospital prospective payment system implemented in 1983, these services became a critical transition in the continuum of care for elderly patients. These services--mainly skilled nursing In response to such dramatic increases and with widespread administrative and legislative concerns about possible fraud and abuse by providers, both regulators and legislators devoted considerable attention to PAC services in the mid-1990s. Regulators aggressively pursued potential fraud and abuse, particularly in HHAs, whereas Congress mandated payment reforms in the Balanced Budget Act of 1997. These regulatory compliance initiatives and the sequential implementation of payment reforms had the potential to lead to reimbursementdriven substitution between settings without regard to the appropriateness of care. Nevertheless, most studies of PAC payment reforms have focused on each setting in isolation, with little investigation of how they might be used interchangeably. To our knowledge, no analyses have simultaneously considered all three major PAC settings across years and used multivariate methods to control for variables affecting their use. Using such an approach, we examined how usage shifted among PAC settings as payment reforms introduced new financial incentives.