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This study examines how ethnic diversity shapes the design of intergovernmental fiscal relations in regimes such as China, where local accountability and resident mobility are largely absent. We argue that in these regimes, ethnic diversity largely captures potential social conflicts and instability, consequently requiring a higher level of fiscal centralization and regional equalization from upper-level governments to preserve social stability. Using provincial and sub-provincial level panel data from China for 1995-2019, we find strong supporting evidence that an increase in a province's ethnic diversity significantly increases fiscal centralization and the provincial government's fiscal equalization efforts. We also show that these effects tend to be stronger in provinces whose leaders have closer ties with the central authority and where local capture is less serious. Our study contributes to a better understanding of ethnic diversity's consequences on the policy choices governments make.

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