This paper investigates China’s annual regional income inequality from 1995 to 2012 based on the Theil index.The results prove that China’s regional inequality has declined steadily since 2003.In order to further investigate the underlying mechanism behind this phenomenon, a theoretical model is constructed based on a special multi-regional input-output model which explicitly distinguishes the production for processing trade and other productions.Then, structural decomposition analysis is adopted to quantify the contribution of each determinant to the change of the regional inequality.The results show that the change in input structure has considerably decreased the regional inequality, while the final demand has substantially increased it.Specially, the rapid expansion of domestic final demand, the deepening production interdependence among regions, and the population shifts from the less-developed regions to developed ones are the main drivers of the decreasing regional disparity.Our empirical results have important policy implications to shrink the regional inequality and promote a balanced development among regions.