The Sonic hedgehog (Shh) pathway plays a critical role in hair follicle physiology and is constitutively active in basal cell carcinomas (BCCs), the most common human malignancy. Type 3 iodothyronine deiodinase (D3), the thyroid hormone-inactivating enzyme, is frequently expressed in proliferating and neoplastic cells, but its role in this context is unknown. Here we show that Shh, through Gli2, directly induces D3 in proliferating keratinocytes and in mouse and human BCCs. We demonstrate that Gli-induced D3 reduces intracellular active thyroid hormone, thus resulting in increased cyclin D1 and keratinocyte proliferation. D3 knockdown caused a 5-fold reduction in the growth of BCC xenografts in nude mice. Shh-induced thyroid hormone degradation via D3 synergizes with the Shh-mediated reduction of the type 2 deiodinase, the thyroxine-activating enzyme, and both effects are reversed by cAMP. This previously unrecognized functional cross-talk between Shh/Gli2 and thyroid hormone in keratinocytes is a pathway by which Shh produces its proliferative effects and offers a potential therapeutic approach to BCC.basal cell carcinoma ͉ thyroxine ͉ differentiation ͉ cancer T hyroid hormone action is regulated by the activity of the deiodinases. Type 2 deiodinase (D2) activates the prohormone thyroxine (T4) by converting it to thyroid hormone (T3), whereas D3, by inactivating T3, terminates thyroid hormone action (1). All vertebrates express D2 and D3 that, in adults, contribute to plasma T3 and T4 homeostasis by their concerted actions with the hypothalamic-pituitary feedback axis. This homeostatic mechanism is possible because the Dio3 gene is transcriptionally stimulated by T3, whereas D2 is inhibited by two thyroid hormone-mediated effects, a transcriptional downregulation of Dio2 as well as protein inactivation by ubiquitination (for review, see ref.2). During development, preprogrammed changes in D2 and D3 expression are thought to regulate intracellular T3 concentrations essential to the normal development of the central nervous system, including the retina and the inner ear (3-6). However, the signals governing the changes in D2 and D3 expression during these complex processes are largely unknown.New insight into the developmental regulation of deiodinase expression has recently been obtained in the chicken growth plate, where Indian hedgehog induces WSB-1, an E3 ubiquitin ligase adaptor that inactivates D2 (7). The hedgehog pathway, acting through the Gli family of transcription factors, determines patterns of cell growth and differentiation in a wide variety of developmental settings (8-13). Given that, in general, signals regulating D2 expression affect D3 in a reciprocal fashion (2), we hypothesized that hedgehog proteins could up-regulate D3 while suppressing D2 expression. To explore this possibility, we turned to skin, a system in which Sonic hedgehog (Shh) is known to play dominant physiological as well as pathological roles (14). Both D2 and D3 are present in skin, a well recognized target of thyroid hormone...