Aridland ecosystems are predicted to be responsive to both increases and decreases in precipitation. In addition, chronic droughts may contribute to encroachment of native C3 shrubs into C4-dominated grasslands. We conducted a long-term rainfall manipulation experiment in native grassland, shrubland and the grass-shrub ecotone in the northern Chihuahuan Desert, USA. We evaluated the effects of 5 years of experimental drought and 4 years of water addition on plant community structure and dynamics. We assessed the effects of altered rainfall regimes on the abundance of dominant species as well as on species richness and subdominant grasses, forbs and shrubs. Nonmetric multidimensional scaling and MANOVA were used to quantify changes in species composition in response to chronic addition or reduction of rainfall. We found that drought consistently and strongly decreased cover of Bouteloua eriopoda, the dominant C4 grass in this system, whereas water addition slightly increased cover, with little variation between years. In contrast, neither chronic drought nor increased rainfall had consistent effects on the cover of Larrea tridentata, the dominant C3 shrub. Species richness declined in shrub-dominated vegetation in response to drought whereas richness increased or was unaffected by water addition or drought in mixed- and grass-dominated vegetation. Cover of subdominant shrubs, grasses and forbs changed significantly over time, primarily in response to interannual rainfall variability more so than to our experimental rainfall treatments. Nevertheless, drought and water addition shifted the species composition of plant communities in all three vegetation types. Overall, we found that B. eriopoda responded strongly to drought and less so to irrigation, whereas L. tridentata showed limited response to either treatment. The strong decline in grass cover and the resistance of shrub cover to rainfall reduction suggest that chronic drought may be a key factor promoting shrub dominance during encroachment into desert grassland.