Progranulin (GRN) and TMEM106B are associated with several common neurodegenerative disorders including frontotemporal lobar degeneration (FTLD). A TMEM106B variant modifies GRN-associated FTLD risk. However, their functional relationship in vivo and the mechanisms underlying the risk modification remain unclear. Here, using transcriptomic and proteomic analyses with Grn^−/− and Tmem106b^−/− mice, we show that, while multiple lysosomal enzymes are increased in Grn^−/− brain at both transcriptional and protein levels, TMEM106B deficiency causes reduction in several lysosomal enzymes. Remarkably, Tmem106b deletion from Grn^−/− mice normalizes lysosomal protein levels and rescues FTLD-related behavioral abnormalities and retinal degeneration without improving lipofuscin, C1q, and microglial accumulation. Mechanistically, TMEM106B binds vacuolar-ATPase accessory protein 1 (AP1). TMEM106B deficiency reduces vacuolar-ATPase AP1 and V0 subunits, impairing lysosomal acidification and normalizing lysosomal protein levels in Grn^−/− neurons. Thus, Grn and Tmem106b genes have opposite effects on lysosomal enzyme levels, and their interaction determines the extent of neurodegeneration.