Abstract: Medicare’s prospective payment system (PPS) for long term-care hospitals (LTCHs) gives providers modest per-diem reimbursements for short stays before jumping discontinuously to a large lump-sum payment after a patient stays a specified number of days. Using Medicare claims data, we show that LTCHs strategically discharge patients after they exceed the large-payment threshold, with identification coming from variation in the length of thresholds across diagnoses and from changes in thresholds within diagnoses over time. We further show that for-profit LTCHs and those within acute-care hospitals are more likely to strategically discharge patients. Using a dynamic structural model, we then evaluate counterfactual payment policies.