Diabetic nephropathy is a leading cause of end-stage kidney failure. Reduced angiopoietin-TIE2 receptor tyrosine kinase signaling in the vasculature leads to increased vascular permeability, inflammation, and endothelial cell loss and is associated with the development of diabetic complications. Here, we identified a mechanism to explain how TIE2 signaling is attenuated in diabetic animals. Expression of vascular endothelial protein tyrosine phosphatase VE-PTP (also known as PTPRB), which dephosphorylates TIE2, is robustly up-regulated in the renal microvasculature of diabetic rodents, thereby reducing TIE2 activity. Increased VE-PTP expression was dependent on hypoxia-inducible factor transcriptional activity in vivo. Genetic deletion of VE-PTP restored TIE2 activity independent of ligand availability and protected kidney structure and function in a mouse model of severe diabetic nephropathy. Mechanistically, inhibition of VE-PTP activated endothelial nitric oxide synthase and led to nuclear exclusion of the FOXO1 transcription factor, reducing expression of pro-inflammatory and pro-fibrotic gene targets. In sum, we identify inhibition of VE-PTP as a promising therapeutic target to protect the kidney from diabetic injury.