Class III HD-ZIP and KANADI gene family members have complementary expression patterns in the vasculature and their gain-of-function and loss-of-function mutants have complementary vascular phenotypes. This suggests that members of the two gene families are involved in the establishment of the spatial arrangement of phloem, cambium and xylem. In this study, we have investigated the role of these two gene families in vascular tissue differentiation, in particular their interactions with the plant hormone auxin. We have analyzed the vasculature of plants that have altered expression levels of Class III HD-ZIP and KANADI transcription factors in provascular cells. Removal of either KANADI or Class III HD-ZIP expression in procambium cells led to a wider distribution of auxin in internal tissues, to an excess of procambium cell recruitment and to increased cambium activity. Ectopic expression of KANADI1 in provascular cells inhibited procambium cell recruitment due to negative effects of KANADI1 on expression and polar localization of the auxin efflux-associated protein PIN-FORMED1. Ectopic expression of Class III HD-ZIP genes promoted xylem differentiation. We propose that Class III HD-ZIP and KANADI transcription factors control cambium activity: KANADI proteins by acting on auxin transport, and Class III HD-ZIP proteins by promoting axial cell elongation and xylem differentiation.