While China's urban-rural income gap has been the focus of many studies, there is a dearth of information on how China’s steady growth in FDI and infrastructure investment has affected the income gap. From the perspective of direct and spatial spillover effects, this paper has empirically assessed such effects using the spatial panel data of local 186 prefecture-level cities from 2010 to 2019. Alternative tests have been conducted to address several econometric issues related to the direct and spatial spillover effects and the spatial panel data. The empirical results indicate that the direct effect of FDI on the urban-income gap is negative and significant but the economic distance weighted spatial spillover effect is positive and significant, suggesting that the growth of FDI has narrowed the urban-rural income gap within the area but has likely widened the gap in other areas. Also, the mechanism of the direct and spatial spillover effects is explored. The major policy recommendations include collaborative development in FDI and infrastructure investment across areas and regions, appropriate relation between regional specialization and diversification, and encouragement and incentives for labor migration across regions.