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BACKGROUND: We wanted to evaluate the most recent, complete data related to the specific effects of the Balanced Budget Act of 1997 relative to the overall financial health of teaching hospitals. We also define cost report variables and calculations necessary for continued impact monitoring. METHODS: We undertook a descriptive analysis of hospital cost report variables for 1996, 1998, and 1999, using simple calculations of total, Medicare, prospective payment system, graduate medical education (GME), and bad debt margins, as well as the proportion with negative total operating margins. RESULTS: Nearly 35% of teaching hospitals had negative operating margins in 1999. Teaching hospital total margins fell by nearly 50% between 1996 and 1999, while Medicare margins remained relatively stable. GME margins have fallen by nearly 24%, however, even as reported education costs have risen by nearly 12%. Medicare + Choice GME payments were less than 10% of those projected. CONCLUSIONS: Teaching hospitals realized deep cuts in profitability between 1996 and 1999; however, these cuts were not entirely attributable to the Balanced Budget Act of 1997. Medicare payments remain an important financial cushion for teaching hospitals, more than one third of which operated in the red. The role of Medicare in supporting GME has been substantially reduced and needs special attention in the overall debate. Medicare + Choice support of the medical education enterprise is 90% less than baseline projections and should be thoroughly investigated. The Medicare Payment Advisory Commission, which has a critical role in evaluating the effects of Medicare policy changes, should be more transparent in its methods.