Sonic Hedgehog (Shh) signals are transduced into nuclear ratios of Gli transcriptional activator versus repressor. The initial part of this process is accomplished by Shh acting through Patched (Ptc) to regulate Smoothened (Smo) activity. The mechanisms by which Ptc regulates Smo, and Smo activity is transduced to processing of Gli proteins remain unclear. Recently, a forward genetic approach in mice identified a role for intraflagellar transport (IFT) genes in Shh signal transduction, downstream of Patched (Ptc) and Rab23. Here, we show that the retrograde motor for IFT is required in the mouse for the phenotypic expression of both Gli activator and repressor function and for effective proteolytic processing of Gli3. Furthermore, we show that the localization of Smo to primary cilia is disrupted in mutants. These data indicate that primary cilia act as specialized signal transduction organelles required for coupling Smo activity to the biochemical processing of Gli3 protein.