In what regime does the cortical circuit operate? Our intracellular studies of surround suppression in cat primary visual cortex (V1) provide strong evidence on this question. Although suppression has been thought to arise from an increase in lateral inhibition, we find that the inhibition that cells receive is reduced, not increased, by a surround stimulus. Instead, suppression is mediated by a withdrawal of excitation. Thalamic recordings and previous work show that these effects cannot be explained by a withdrawal of thalamic input. We find in theoretical work that this behavior can only arise if V1 operates as an inhibition-stabilized network (ISN), in which excitatory recurrence alone is strong enough to destabilize visual responses but feedback inhibition maintains stability. We confirm two strong tests of this scenario experimentally and show through simulation that observed cell-to-cell variability in surround effects, from facilitation to suppression, can arise naturally from variability in the ISN.