BACKGROUND: The rapidly expanding proportion of the US population 65 years and older is anticipated to have a profound effect on health care expenditures. Whether the changing health status of older Americans will modulate this effect is not well understood. This study sought to determine the relationship between functional status and government-reimbursed health care services in older persons. METHODS: Longitudinal cohort study of a representative sample of community-dwelling persons 72 years or older. Clinical data were linked with data on 2-year expenditures for Medicare-reimbursed hospital, outpatient, and home care services and Medicare- and Medicaid-reimbursed nursing home services. Per capita expenditures associated with different functional status transitions were calculated, as were excess expenditures associated with functional disability adjusted for demographic, health, and psychosocial variables. RESULTS: The 19.6% of older persons who had stable functional dependence or who declined to dependence accounted for almost half (46.3%) of total expenditures. Persons in these groups had an excess of approximately $10 000 in expenditures in 2 years compared with those who remained independent. The 9.6% of patients who were dependent at baseline accounted for more than 40.0% of home health and nursing home expenditures; the 10.0% who declined accounted for more than 20.0% of hospital, outpatient, and nursing home expenditures. CONCLUSIONS: Functional dependence places a large burden on government-funded health care services. Whereas functional decline places this burden on short- and long-term care services, stable functional dependence places the burden predominantly on long-term care services. Declining rates of functional disability and interventions to prevent disability hold promise for ameliorating this burden.