The Polycomb repressive complexes PRC1, PRC2, and PR-DUB repress target genes by modifying their chromatin. In Drosophila, PRC1 compacts chromatin and monoubiquitinates histone H2A at lysine 118 (H2Aub1), whereas PR-DUB is a major H2Aub1 deubiquitinase, but how H2Aub1 levels must be balanced for Polycomb repression remains unclear. We show that in early embryos, H2Aub1 is enriched at Polycomb target genes, where it facilitates H3K27me3 deposition by PRC2 to mark genes for repression. During subsequent stages of development, H2Aub1 becomes depleted from these genes and is no longer enriched when Polycomb maintains them repressed. Accordingly, Polycomb targets remain repressed in H2Aub1-deficient animals. In PR-DUB catalytic mutants, high levels of H2Aub1 accumulate at Polycomb target genes, and Polycomb repression breaks down. These high H2Aub1 levels do not diminish Polycomb protein complex binding or H3K27 trimethylation but increase DNA accessibility. We show that H2Aub1 interferes with nucleosome stacking and chromatin fiber folding in vitro. Consistent with this, Polycomb repression defects in PR-DUB mutants are exacerbated by reducing PRC1 chromatin compaction activity, but Polycomb repression is restored if PRC1 E3 ligase activity is removed. PR-DUB therefore acts as a rheostat that removes excessive H2Aub1 that, although deposited by PRC1, antagonizes PRC1-mediated chromatin compaction.