Interferon-gamma induces an irreversible growth arrest and squamous differentiation in normal human epidermal keratinocytes. We present for the first time a careful biochemical analysis of the cell-cycle-related events that occur during interferon-gamma treatment of normal human epidermal keratinocytes. The interferon-gamma-induced irreversible growth arrest state is characterized by inhibition of cyclin-dependent kinases, prevention of Rb and p130 (Rb2) phosphorylation, and increases in p27(Kip1), p16(Ink4a), and p130 proteins, together with a transient increase in p21(Waf1/Cip1). Cells derived from squamous cell carcinomas are less responsive to interferon-gamma and do not terminally differentiate. We exploited these differences in response to interferon-gamma in order to identify the particular molecular defects in cell cycle control that promote carcinogenesis in squamous epithelia. In several squamous cell carcinoma cell lines as well as in interferon-gamma-insensitive HaCaT cells, interferon gamma was unable to significantly induce levels of p130 and/or p16 protein. In addition, p21 association with cdk2 complexes was undetectable in either the absence or the presence of interferon-gamma and, unlike normal human epidermal keratinocytes, p27 association with cdk2 did not increase with interferon-gamma treatment. These multiple defects appear to be intrinsic to the mechanisms of cell cycle regulation rather than due to defects in the interferon-gamma signaling pathway, as induction of several interferon-gamma-responsive genes including Stat 1, IRF-1, and p21 itself was normal. Interestingly, exogenous expression of p21 protein in the squamous cell carcinoma cell lines by adenovirus carrying wildtype p53 or p21 cDNA cooperated with interferon-gamma to produce a greater inhibition of growth than either agent alone, even though p21 protein could barely be detected in cdk2 complexes. We conclude that squamous cell carcinoma cells have intrinsic defects in their ability to regulate cdk-cki complexes in response to differentiation signals.