China's main share index fell 6.5% in Wednesday trading following Beijing's decision to triple the tax on stock transactions.
Many ordinary Chinese people have invested in shares
With the government aiming to cool the country's overheated stock markets, the main Shanghai Composite Index closed down 281.8 points at 4,053.1.
Some analysts said the dip in share prices was only likely to be temporary.
The World Bank now predicts China's economy will expand 10.4% this year but says it does not appear overheated.
The Bank had previously expected a 9.6% rise for 2007.
Under Beijing's latest move to cool share prices, which came into effect on Wednesday, the stamp duty on share trading rose from 0.1% to 0.3%.
The Shanghai Composite Index had risen 62% this year to Tuesday's record close and has quadrupled in value since the start of 2006.
"This could trigger a correction, but we don't see a change in the overall trend," said Thomas Gruener from Landesbank Berlin.
"The environment for equities is still very good," he added.
The falls in Shanghai depressed sentiment in other Erading with all of the major European indices trading lower - though they clawed back most of the losses by the close of play.
London's FTSE 100 was down 0.1%, with the benchmark French and German markets each 0.2% lower, while Wall Street reversed early falls.
Chinese state media reported a government official as saying that the tax rise, which has been approved by the Chinese cabinet, "is intended to help promote the healthy development of the securities markets".
Strong demand from domestic investors has lifted Chinese stocks.
However, some analysts have warned that a stock market bubble is being created and last week former Federal Reserve chairman Alan Greenspan warned that the Chinese stock market could undergo a dramatic correction.
One of the main factors behind the surge in shares has been a willingness among ordinary people, such as students and pensioners, to buy shares.
Instead of leaving their savings in bank accounts, many people are now using the cash to buy shares in the hope of receiving better returns.
According to industry figures, 300,000 people a day opened brokerage accounts in China last week.
On Tuesday, China's Ministry of Public Security warned investors to be suspicious of phone calls, e-mails and websites touting supposedly highly profitable stocks.
"There has been a rise in the number of cases of illegal activities in the stock market, which has undermined the normal market order," the ministry said.