The role of dementia and other mental disorders in nursing home case-mix classification systems has been an area of controversy. The role of mental dysfunctions was considered in developing a new case-mix measurement system for facility payment in a national demonstration to understand staff time use in nursing homes. Nursing staff (nurses and aides) time and resident assessment data were collected for 6,663 nursing home residents in 6 states. Measures of signs and symptoms of cognitive impairment (dementia), depression, and delirium were created based on items from the new National Minimum Data Set. These measures then were used to determine whether mental dysfunctions were predictive of resource use (nursing staff times and costs) when controlling for other case-mix variables. Cognitive impairment was associated with slightly higher staff time only in less physically-impaired residents without serious medical conditions and not receiving heavy rehabilitation. Similarly, depression and delirium were associated with higher resource use only in selected types of residents. Based on these findings, the new Resource Utilization Groups Version III (RUG-III) contain a major category of residents who are cognitively impaired but not severely dependent in Activities of Daily Living. Depression is used to differentiate subgroups of residents with major medical conditions such as hemiplegia and aphasia. Delirium, when used together with other resident characteristics, was not found useful in explaining resource use. Case-mix groups defined by mental dysfunctions can foster improved care, but careful consideration must be given to appropriate incentives and documentation requirements for providers.