Exposure to environmental teratogenic pollutant leads to severe birth defects. However, the biological events underlying these developmental abnormalities remain undefined. Here, we report a molecular link between an environmental stress response pathway and key developmental genes during craniofacial development. Strikingly, mutant mice with impaired Pax3/7 function display severe craniofacial defects. We show that these are associated with an upregulation of the signaling pathway mediated by the Aryl hydrocarbon receptor (AHR), the receptor to 2,3,7,8-tetrachlorodibenzo-p-dioxin (TCDD), revealing a genetic interaction between Pax3 and AHR signaling. Activation of AHR signaling in Pax3-deficient embryos drives facial mesenchymal cells out of the cell cycle through the upregulation of p21 expression. Accordingly, inhibiting AHR activity rescues the cycling status of these cells and the facial closure of Pax3/7 mutants. Together, our findings demonstrate that the regulation of AHR signaling by Pax3/7 is required to protect against TCDD/AHR-mediated teratogenesis during craniofacial development.