The classical view of neural plate development held that it arises from the ectoderm, after its separation from the mesodermal and endodermal lineages. However, recent cell-lineage-tracing experiments indicate that the caudal neural plate and paraxial mesoderm are generated from common bipotential axial stem cells originating from the caudal lateral epiblast. Tbx6 null mutant mouse embryos which produce ectopic neural tubes at the expense of paraxial mesoderm must provide a clue to the regulatory mechanism underlying this neural versus mesodermal fate choice. Here we demonstrate that Tbx6-dependent regulation of Sox2 determines the fate of axial stem cells. In wild-type embryos, enhancer N1 of the neural primordial gene Sox2 is activated in the caudal lateral epiblast, and the cells staying in the superficial layer sustain N1 activity and activate Sox2 expression in the neural plate. In contrast, the cells destined to become mesoderm activate Tbx6 and turn off enhancer N1 before migrating into the paraxial mesoderm compartment. In Tbx6 mutant embryos, however, enhancer N1 activity persists in the paraxial mesoderm compartment, eliciting ectopic Sox2 activation and transforming the paraxial mesoderm into neural tubes. An enhancer-N1-specific deletion mutation introduced into Tbx6 mutant embryos prevented this Sox2 activation in the mesodermal compartment and subsequent development of ectopic neural tubes, indicating that Tbx6 regulates Sox2 via enhancer N1. Tbx6-dependent repression of Wnt3a in the paraxial mesodermal compartment is implicated in this regulatory process. Paraxial mesoderm-specific misexpression of a Sox2 transgene in wild-type embryos resulted in ectopic neural tube development. Thus, Tbx6 represses Sox2 by inactivating enhancer N1 to inhibit neural development, and this is an essential step for the specification of paraxial mesoderm from the axial stem cells.