Why do governments centralize control over regions? We present a theory of the transition from indirect to direct rule, focusing on the strategic interaction between a ruler and local potentates who provide civil order in exchange for a share of tax revenue. When the threat of rebellion from below falls and elites become less crucial intermediaries, the ruler is able to centralize power, replacing local potentates with direct agents of the state and investing in a fiscal bureaucracy for future state development. We assess the theory using subnational data from sixteenth- and seventeenth-century Mexico around the time of a dramatic demographic collapse, which undermined the threat of domestic conflict. Using a difference-in-differences approach and an instrumental variables empirical strategy based on the climate shocks associated with a virulent series of epidemics, we show that state centralization occurred faster in areas experiencing a more dramatic decline in population.