We find that inactivation of a Drosophila homolog of the tumor suppressor APC (D-APC) causes retinal neuronal degeneration and pigment cell hypertrophy, a phenotype remarkably similar to that found in humans with germline APC mutations. Retinal degeneration in the D-APC mutant results from apoptotic cell death, which accompanies a defect in neuronal differentiation. Reduction in the Drosophila beta-catenin, Armadillo (Arm), rescues the differentiation defect and prevents apoptosis in the D-APC mutant, while Arm overexpression mimics D-APC inactivation. A mutation in dTCF, the DNA-binding protein required in Arm-mediated signal transduction, can eliminate the cell death without rescuing the differentiation defect in D-APC mutants. Uncoupling of these two Arm-induced processes suggests a novel role for the Arm/dTCF complex in the activation of apoptosis.