The Hippo pathway senses cell density information to control tissue growth by regulating the localization of the transcriptional regulators TAZ and YAP (TAZ/YAP). TAZ/YAP also regulate TGF-β-SMAD signaling, but whether this role is linked to cell density sensing is unknown. Here we demonstrate that TAZ/YAP dictate the localization of active SMAD complexes in response to cell density-mediated formation of polarity complexes. In high-density cell cultures, the Hippo pathway drives cytoplasmic localization of TAZ/YAP, which sequesters SMAD complexes, thereby suppressing TGF-β signaling. We show that during mouse embryogenesis, this is reflected by differences in TAZ/YAP localization, which define regions of active SMAD2/3 complexes. Interfering with TAZ/YAP phosphorylation drives nuclear accumulation of TAZ/YAP and SMAD2/3. Furthermore, we demonstrate that the Crumbs polarity complex interacts with TAZ/YAP, which relays cell density information by promoting TAZ/YAP phosphorylation, cytoplasmic retention, and suppressed TGF-β signaling. Accordingly, disruption of the Crumbs complex enhances TGF-β signaling and predisposes cells to TGF-β-mediated epithelial-to-mesenchymal transitions.