The cyclin-dependent kinase inhibitor protein, p27^Kip1, is necessary for the timing of cell cycle withdrawal that precedes terminal differentiation in oligodendrocytes of the optic nerve. Although p27^Kip1 is widely expressed in the developing central nervous system, it is not known whether this protein has a similar role in neuronal differentiation. To address this issue, we have examined the expression and function of p27^Kip1 in the developing retina, a well-characterized part of the central nervous system. p27^Kip1 is expressed in a pattern coincident with the onset of differentiation of most retinal cell types. In vitro analyses show that p27^Kip1 accumulation in retinal cells correlates with cell cycle withdrawal and differentiation, and when overexpressed, p27^Kip1 inhibits proliferation of the progenitor cells. Furthermore, the histogenesis of photoreceptors and Müller glia is extended in the retina of p27^Kip1-deficient mice. Finally, we examined the adult retinal dysplasia in p27^Kip1-deficient mice with cell-type-specific markers. Contrary to previous suggestions that the dysplasia is caused by excess production of photoreceptors, we suggest that the dysplasia is due to the displacement of reactive Müller glia into the layer of photoreceptor outer segments. These results demonstrate that p27^Kip1 is part of the molecular mechanism that controls the decision of multipotent central nervous system progenitors to withdraw from the cell cycle. Second, postmitotic Müller glia have a novel and intrinsic requirement for p27^Kip1 in maintaining their differentiated state.