Abstract: Continuing to promote urbanization and the relocation of ecologically overburdened populations remains an inevitable trend for counties within national key ecological function zones, and vertical ecological compensation provides an important economic instrument to support this process. Based on panel data from 403 counties during 2007—2022, we take the inclusion of counties in national key ecological function zones as a natural experiment and construct a multi-period difference-in-differences model to evaluate the effects and mechanisms of ecological compensation policies on county-level urbanization. The results show that ecological compensation and preferential fiscal transfer payments significantly promote county-level urbanization, and this finding remains robust after replacing the dependent variable, adjusting the sample range, and conducting PSM-DID tests. Economic development and government intervention play positive and negative moderating roles, respectively. The policy effect is mainly observed in counties with a stronger industrial foundation and is more pronounced in counties with lower levels of urbanization. Accordingly, vertical ecological compensation policies should improve differentiated allocation mechanisms, with greater support directed to ecological function counties that shoulder heavy ecological protection tasks, have weak fiscal capacity and obvious public service shortcomings, yet possess certain potential for population carrying capacity. Ecological function counties should strictly observe ecological protection red lines and control land development intensity, while guiding ecologically overburdened populations to relocate in an orderly manner and moderately concentrate in county seats and key towns, so as to promote local urbanization within the county. At the same time, ecological compensation funds should provide stronger support for green industry cultivation, employment absorption, and public service improvement. Differentiated measures should also be adopted according to industrial foundation, government intervention intensity, and urbanization stage, in order to improve fund-use efficiency and avoid fiscal dependence and disorderly expansion.