Stratified epithelium displays an equilibrium between proliferation and cell cycle arrest, a balance that is disrupted in basal cell carcinoma (BCC). Sonic hedgehog (Shh) pathway activation appears sufficient to induce BCC, however, the way it does so is unknown. Shh-induced epidermal hyperplasia is accompanied by continued cell proliferation in normally growth arrested suprabasal cells in vivo. Shh-expressing cells fail to exit S and G2/M phases in response to calcium-induced differentiation and also resist exhaustion of replicative growth capacity. In addition, Shh blocks p21CIP1/WAF1-induced growth arrest. These data indicate that Shh promotes neoplasia by opposing normal stimuli for epithelial cell cycle arrest.