Theoretical work based on social identity theory predicts that population diversity undermines redistributive public policies. This article tests this proposition exploiting an exogenous shock in diversity due to Germany’s reunification. In contrast to previous work on ethno-linguistic or racial heterogeneity, we specifically analyze religious diversity, which is an increasingly relevant social cleavage in many countries. Our main results corroborate that increasing religious diversity leads to a change in fiscal policies in Bavarian municipalities over the 1983–2005 period. Moreover, we find some evidence of declining individual-level local identification over the post-reunification period, which suggests that the observed fiscal effects are indeed linked to the theoretical mechanism of individuals’ social identification. Finally, we highlight an important mediating role for the democratic process, since the observed fiscal effects strengthen considerably following Bavarian municipalities’ first local elections after the reunification migration wave (March 1996) and a legal change allowing local referenda on public policies (October 1995).