The Drosophila protein Shaggy (Sgg, also known as Zeste-white3, Zw3) and its vertebrate orthologue glycogen synthase kinase 3 (GSK3) are inhibitory components of the Wingless (Wg) and Wnt pathways. Here we show that Sgg is also a negative regulator in the Hedgehog (Hh) pathway. In Drosophila, Hh acts both by blocking the proteolytic processing of full-length Cubitus interruptus, Ci (Ci155), to generate a truncated repressor form (Ci75), and by stimulating the activity of accumulated Ci155 (refs 2-6). Loss of sgg gene function results in a cell-autonomous accumulation of high levels of Ci155 and the ectopic expression of Hh-responsive genes including decapentaplegic (dpp) and wg. Simultaneous removal of sgg and Suppressor of fused, Su(fu), results in wing duplications similar to those caused by ectopic Hh signalling. Ci is phosphorylated by GSK3 after a primed phosphorylation by protein kinase A (PKA), and mutating GSK3-phosphorylation sites in Ci blocks its processing and prevents the production of the repressor form. We propose that Sgg/GSK3 acts in conjunction with PKA to cause hyperphosphorylation of Ci, which targets it for proteolytic processing, and that Hh opposes Ci proteolysis by promoting its dephosphorylation.