I had the same problem, until I realized that if I insert one of the smaller sizes (ie, thumbnail, small, medium, large, not full size), WP correctly inserts the edited image.
It seems like the image editing functions are really half baked, for example: if i resize the image, the link url in the insert dialog still reflects the original image, and the dimensions in the sizes row is not updated with the new size until we refresh the dialog.
edit: Oops, I apologize – I was using WordPress Mu and it seems that regular wordpress is working correctly.
