Transcription factors regulate tissue patterning and cell fate determination during development; however, expression of early regulators frequently abates upon differentiation, suggesting that they may also play a role in maintaining an undifferentiated phenotype. The transcription factor paired box 3 (Pax3) is expressed by multipotent neural crest precursors and is implicated in neural crest disorders in humans such as Waardenburg syndrome. Pax3 is required for development of multiple neural crest lineages and for activation of lineage-specific programs, yet expression is generally extinguished once neural crest cells migrate from the dorsal neural tube and differentiate. Using a murine Cre-inducible system, we asked whether persistent Pax3 expression in neural crest derivatives would affect development or patterning. We found that persistent expression of Pax3 in cranial neural crest cells resulted in cleft palate, ocular defects, malformation of the sphenoid bone, and perinatal lethality. Furthermore, we demonstrated that Pax3 directly regulates expression of Sostdc1, a soluble inhibitor of bone morphogenetic protein (BMP) signaling. Persistent Pax3 expression renders the cranial crest resistant to BMP-induced osteogenesis. Thus, one mechanism by which Pax3 maintains the undifferentiated state of neural crest mesenchyme may be to block responsiveness to differentiation signals from the environment. These studies provide in vivo evidence for the importance of Pax3 downregulation during differentiation of multipotent neural crest precursors and cranial development.