Heparan sulfate proteoglycans (HSPGs) are required for various signaling pathways, one of which is the bone morphogenetic protein (BMP) signaling pathway. N-deacetylase/N-sulfotransferase-1 (NDST1) participates in synthesizing heparan sulfate (HS) chains of HSPGs, and is involved in bone and lung development. Here, we report that in spite of the redundant expression of Ndst2, Ndst3 and Ndst4 genes, Ndst1–/– mice display defective differentiation of lung cells and increased cell proliferation. Loss of Ndst1 in the lung enhances downstream BMP signaling in vivo. Noggin, which is an antagonist of BMP, can rescue the Ndst1–/– lung morphogenetic defects in explant cultures. Further studies in vitro indicated that loss of Ndst1 significantly impairs BMP internalization by decreasing BMP binding to endogenous HS. Exogenous heparin can rescue both the BMP signaling and BMP internalization abnormalities in Ndst1–/– lung. Thus, we propose that HS regulates BMP signaling by controlling the balance between BMP binding to HS, and that BMP receptors and NDST1-dependent modification are essential for this process. The results suggest that NDST1-dependent HS is essential for proper functioning of BMP in embryonic lung development.