Government sources said on Sunday that the decision, which has to be ratified by parliament, was adopted by 16 votes to two at the weekly gathering of ministers.
Under the terms of the legislation, Palestinians from the West Bank or Gaza Strip are disqualified from gaining Israeli nationality through marriage.
The law also blocks the reunification of many families split between Israel and the occupied territories.
However, about 300 Palestinians will be able to claim citizenship to allow family reunification, said Interior Minister Ophir Pines, pointing out that the exception applies to Palestinian men over 35 and women over 25.
The law, which was first adopted by parliament in July 2003, has been denounced as racist by both Arab Israeli and left-wing MPs.
"The issue here is whether we really want a situation where there is different legislation for different sectors of the public," Pines told Channel Two television, noting that Israel did not generally limit immigration rights to Israelis' spouses.
The government has defended the bill on the grounds that dozens of Israelis have been killed by Palestinians who gained citizenship and residency rights through marriage.
"The issue here is whether we really want a situation where there is different legislation for different sectors of the public"
Israeli interior minister
Justice Minister Tzippi Livni, who proposed the discussion of the amendment, said limiting access by an estimated 1200 Palestinians from the West Bank and Gaza who were married to Israelis was a demographic as well as a security issue.
"There is nothing wrong with looking to safeguard Israel's Jewish majority by law," she told Channel One television.
Israeli Arabs see the law as discriminating against their community. While mostly sympathetic to a four and a half year-old Palestinian revolt against Israeli occupation, Israeli Arabs have rarely taken up arms themselves.