The transforming growth factor-beta (TGF-beta) pathway has tumor-suppressor activity in many epithelial tissues. Because TGF-beta is a potent inhibitor of epithelial cell proliferation, it has been widely assumed that this property underlies the tumor-suppressor effect. Here, we have used a xenograft model of breast cancer to show that endogenous TGF-beta has the potential to suppress tumorigenesis through a novel mechanism, involving effects at two distinct levels in the hierarchy of cellular progeny that make up the epithelial component of the tumor. First, TGF-beta reduces the size of the putative cancer stem or early progenitor cell population, and second it promotes differentiation of a more committed, but highly proliferative, progenitor cell population to an intrinsically less proliferative state. We further show that reduced expression of the type II TGF-beta receptor correlates with loss of luminal differentiation in a clinical breast cancer cohort, suggesting that this mechanism may be clinically relevant. At a molecular level, the induction of differentiation by TGF-beta involves down-regulation of Id1, and forced overexpression of Id1 can promote tumorigenesis despite persistence of the antiproliferative effect of TGF-beta. These data suggest new roles for the TGF-beta pathway in regulating tumor cell dynamics that are independent of direct effects on proliferation.