"Autos are the giants of energy consumption and pollution emissions and this is a major part of the effort to conserve resources and reduce emissions," the ministry said.
The sales tax for cars with engines at or smaller than 1 liter would drop to 1 percent from the current 3 percent, the Finance Ministry said.
Tax rates of 5 percent to 9 percent for vehicles with other-sized engines remain unchanged.
China is the world's second biggest market for passenger cars, with some analysts forecasting that sales could reach 10 million this year.
The country's big cities have imposed auto emissions standards that exceed those in the U.S. and are at least equal to European levels. Shanghai has banned heavily polluting small motor scooters and limits access to its downtown areas by vehicles failing to meet clean air standards.
At the same time, authorities are seeking ways to reduce fuel consumption amid major shortages, especially of diesel.
But overall, China appears to have made little headway in its struggle to reduce auto emissions, seen most prominently in the effort to keep smoggy Beijing's skies clear during the Olympic games.
Vehicle exhaust accounts for about 80 percent of urban air pollution. Many cities are frequently cloaked in a toxic gray haze that has grown worse as the numbers of vehicles on the roads has risen precipitously in recent years.
Pollution by large commercial vehicles and many buses appears to go unchecked.
Auto purchases are less affected by high global oil prices in China than in the West because government controls keep retail gasoline and diesel prices at levels that are among the world's lowest.
While the majority of passenger cars sold in China are compact cars, drivers who can afford them are increasingly opting for bigger vehicles. The China Association of Automobile Manufacturers reported that sales of big sedans rose nearly 50 percent in the first half of this year, while automakers say sales of SUVs and luxury sedans have doubled.