p-Hydroxybenzoate hydroxylase (PHBH) is the model enzyme for the microbial flavin-dependent mono-oxygenases. The aromatic hydroxylation of p-hydroxybenzoate by the reactive C4a-hydroperoxyflavin cofactor intermediate in PHBH has been studied by a combined ab initio quantum mechanics and molecular mechanics (QM/MM) method. Starting from a model of the C4a-hydroperoxyflavin intermediate in the PHBH reaction cycle, built on the basis of the crystal structure of the enzyme-substrate complex, a pathway for the hydroxylation step was calculated by imposing a reaction coordinate involving cleavage of the peroxide oxygen-oxygen bond and bond formation between the C3 atom of the substrate and the distal oxygen of the peroxide moiety of the cofactor. A QM/MM potential was used in which the QM region (49 atoms) was treated at the ab initio HF level with the 3-21G(d) or 6-31G(d) basis sets. The accuracy of various aspects of the QM/MM method for this system has been tested by comparison to higher-level calculations. Inclusion of electron correlation, applied here as B3LYP/6-311+G(d,p) and LMP2/6-31+G(d) single point energy corrections to the ab initio QM/MM structures, is shown to be essential to obtain barriers in agreement with the experimental rate constant. The calculated pathways support electrophilic aromatic substitution as the mechanism of this rate-limiting step in the PHBH catalyzed reaction cycle. The polarization of the QM region by the enzyme has been investigated. A potentially important catalytic interaction between the reacting OH group in the transition state (formally OH+) and the backbone carbonyl of the Pro293 residue is identified from the calculations and is analyzed in detail. This interaction is calculated to lower the barrier by a catalytically significant 2-3 kcal/mol, corresponding to a 100-fold rate enhancement.