Transcription is regulated by the state of phosphorylation of a heptapeptide repeat known as the carboxy-terminal domain (CTD) present in the largest subunit of RNA polymerase II (RNAPII). RNAPII that associates with transcription initiation complexes contains an unphosphorylated CTD, whereas the elongating polymerase has a phosphorylated CTD. Transcription factor IIH has a kinase activity specific for the CTD that is stimulated by the formation of a transcription initiation complex. Here, we report the isolation of a cDNA clone encoding a 150-kD polypeptide, which, together with RNAPII, reconstitutes a highly specific CTD phosphatase activity. Functional analysis demonstrates that the CTD phosphatase allows recycling of RNAPII. The phosphatase dephosphorylates the CTD allowing efficient incorporation of RNAPII into transcription initiation complexes, which results in increased transcription. The CTD phosphatase was found to be active in ternary elongation complexes. Moreover, the phosphatase stimulates elongation by RNAPII; however, this function is independent of its catalytic activity.