Rates of ecosystem processes such as decomposition are likely to change as a result of human impacts on the environment. In southern California, climate change and nitrogen (N) deposition in particular may alter biological communities and ecosystem processes. These drivers may affect decomposition directly, through changes in abiotic conditions, and indirectly through changes in plant and decomposer communities. To assess indirect effects on litter decomposition, we reciprocally transplanted microbial communities and plant litter among control and treatment plots (either drought or N addition) in a grassland ecosystem. We hypothesized that drought would reduce decomposition rates through moisture limitation of decomposers and reductions in plant litter quality before and during decomposition. In contrast, we predicted that N deposition would stimulate decomposition by relieving N limitation of decomposers and improving plant litter quality. We also hypothesized that adaptive mechanisms would allow microbes to decompose litter more effectively in their native plot and litter environments. Consistent with our first hypothesis, we found that drought treatment reduced litter mass loss from 20.9% to 15.3% after six months. There was a similar decline in mass loss of litter inoculated with microbes transplanted from the drought treatment, suggesting a legacy effect of drought driven by declines in microbial abundance and possible changes in microbial community composition. Bacterial cell densities were up to 86% lower in drought plots and at least 50% lower on litter derived from the drought treatment, whereas fungal hyphal lengths increased by 13–14% in the drought treatment. Nitrogen effects on decomposition rates and microbial abundances were weaker than drought effects, although N addition significantly altered initial plant litter chemistry and litter chemistry during decomposition. However, we did find support for microbial adaptation to N addition with N-derived microbes facilitating greater mass loss in N plots than in control plots. Our results show that environmental changes can affect rates of ecosystem processes directly through abiotic changes and indirectly through microbial abundances and communities. Therefore models of ecosystem response to global change may need to represent microbial biomass and community composition to make accurate predictions.