The benchmark composite Shanghai share index closed 330.34 points or 8.26% down at 3,670.40.
Chinese shares were hit last week after Beijing opted to triple the tax on stock transactions.
Investors fear China might now embark on a capital gains tax to further cool China's break-neck economic growth.
"Investors are still panicking about recent market talk that the government might levy capital gain taxes," said Wang Jun, an analyst with Merchants Securities.
"In any event many can still sell their holdings and make a big profit," he added.
Despite the drop, some analysts say this is likely to be only be a temporary slide.
Even if the government does embark on more taxes, this will not thwart the overall upward trend of China's stock market, they argue.
China has issued a range of measures recently as part of wider economic reforms, including a new bankruptcy law giving creditors precedence over workers.