This paper investigates the potential causal relationship(s) between China’s urbanization and income inequality since the start of the economic reform. Based on the economic theory of urbanization and income distribution, we analyze the annual time series of China’s urbanization rate and Gini index from 1978 to 2014. The results show that urbanization has an immediate alleviating effect on income inequality, as indicated by the negative relationship between the two time series at the same year (lag = 0). However, urbanization also seems to have a lagged aggravating effect on income inequality, as indicated by positive relationship between urbanization and the Gini index series at lag 1. Although the link between urbanization and income inequality is not surprising, the lagged aggravating effect of urbanization on the Gini index challenges the popular belief that urbanization in post-reform China generally helps reduce income inequality. At deeper levels, our results suggest an urgent need to focus on the social dimension of urbanization as China transitions to the next stage of modernization. Comprehensive social reforms must be prioritized to avoid a long-term economic dichotomy and permanent social segregation.