The Spt-Ada-Gcn5-acetyltransferase (SAGA) chromatin-modifying complex possesses acetyltransferase and deubiquitinase activities. Within this modular complex, Ataxin-7 anchors the deubiquitinase activity to the larger complex. Here we identified and characterized Drosophila Ataxin-7 and found that reduction of Ataxin-7 protein results in loss of components from the SAGA complex. In contrast to yeast, where loss of Ataxin-7 inactivates the deubiquitinase and results in increased H2B ubiquitination, loss of Ataxin-7 results in decreased H2B ubiquitination and H3K9 acetylation without affecting other histone marks. Interestingly, the effect on ubiquitination was conserved in human cells, suggesting a novel mechanism regulating histone deubiquitination in higher organisms. Consistent with this mechanism in vivo, we found that a recombinant deubiquitinase module is active in the absence of Ataxin-7 in vitro. When we examined the consequences of reduced Ataxin-7 in vivo, we found that flies exhibited pronounced neural and retinal degeneration, impaired movement, and early lethality.