The four-point plan, which emerged after talks between both sides, is to resolve disputes by giving every party a voice in how security forces operate against violence on a neighbourhood by neighbourhood level.
Nuri al-Maliki, Iraq's prime minister, said: "We have taken the decision to end sectarian hatred once and for all. We have vowed before Almighty God to stop the bloodshed."
Local committees will be formed in each Baghdad district, made up of representatives of every party, religious and tribal leaders and security officials, to consult on security efforts.
A Sunni representative, for example, could raise a complaint if he feels police are not pursuing Shia fighters after an attack.
A central committee, also made up of all the parties, will co-ordinate with the armed forces.
In a possible boost to the effort to rein in the violence, a radical cleric who heads one of the most powerful Shia militias, Muqtada al-Sadr, has ordered his followers to put aside their weapons temporarily, an al-Sadr spokesman said.
Al-Maliki announced his plan hours after gunmen abducted 14 computer shop employees in a midday attack in central Baghdad on Monday, the second mass kidnapping in as many days.
The bodies of seven of 24 captives seized on Sunday were found dumped in southern Baghdad. Sunni politicians blamed Shia militias for both mass kidnappings and demanded the government should take action.
Al-Maliki announced a 24-point reconciliation plan when he took office in May, which laid down ways to tackle violence, including an amnesty for fighters who put down their weapons, as well as security crackdowns.
So far, his previous plan has done little to stem the daily killings.
In addition to the local and central committees, the new plan calls for the setting of a media committee and a monthly review of progress, al-Maliki said.
However, it does not directly tackle the issue of cracking down on Shia militias, a step Sunnis demand but many Shia oppose.
In theory, the committees would give Sunnis a venue to press security forces to take action against fighters. But Shia on the committee would have an equal chance to try to prevent action.
The plan endorsed by al-Maliki to stop sectarian killings in that country offers a "ray of hope", the ranking Democrat on the Senate's Armed Services Committee said on Tuesday.
Senator Carl Levin said he was hopeful that the four-point plan announced by al-Maliki to unite Shia and Sunni parties in his government would end sectarian violence. But Levin also voiced concerns that it lacked a plan to disband the militias that have been blamed for some of the ethnic and sectarian fighting.
"While there is a ray of hope because there is an announcement, nonetheless we have to be very, very cautious to see whether it leads to anything concrete," Levin said in a conference call with reporters from Israel. "At least it's a bit of optimism that we leave with."
Levin was traveling with Senate Armed Services Committee Republican chairman John Warner, Republican Jeff Sessions and Democrat Mark Pryor, on a five-day trip to Jordan, Iraq and Israel. They met with al-Maliki, Jordan's King Abdullah II, the Iraqi president and vice president, and General George Casey, the top US commander in Iraq.