The Hedgehog (Hh) morphogen gradient is required for patterning during metazoan development, yet the mechanisms involved in Hh apical and basolateral release and how this influences short- and long-range target induction are poorly understood. We found that depletion of the GTPase Rab8 in Hh-producing cells induces an imbalance between the level of apically and laterally released Hh. This leads to non-cell-autonomous differential effects on the expression of Hh target genes, namely an increase in its short-range targets and a concomitant decrease in long-range targets. We further found that Rab8 regulates the endocytosis and apico-basal distribution of Ihog, a transmembrane protein known to bind to Hh and to be crucial for establishment of the Hh gradient. Our data provide new insights into morphogen gradient formation, whereby morphogen activity is functionally distributed between apically and basolaterally secreted pools.