Under the Balanced Budget Refinement Act (BBRA) of 1999, the secretary of health and human services was mandated to implement a prospective payment system (PPS) for psychiatric inpatient facilities that were exempt from the Medicare inpatient PPS. This paper reviews the reason for the initial "distinct-part" exemption, describes research that has been conducted to inform the development of a psychiatric inpatient PPS, and examines some of the issues that must be addressed as a PPS is designed. In addition, some changes in the overall inpatient psychiatric hospital sector are discussed.