The so-called climate package, which includes plans to reduce rail prices and increase taxes on air travel, will take effect on January 1st after months of wrangling.
Previously blocked by a dispute over costing, the bill was passed by the upper house after MPs reached a compromise on a higher carbon price earlier this week.
“We have achieved a national consensus on climate that will give us fresh momentum to reach our climate goals,” said Economy Minister and close Merkel ally Peter Altmaier.
The package is intended to help Europe's largest economy reduce greenhouse gas emissions by 55 percent by 2030 compared to 1990 levels.
That promises to be a huge challenge in a country that despite its green reputation abroad remains heavily dependent on polluting coal power and has a fondness for gas-guzzling cars.
The climate package has already attracted criticism from environmentalists and business lobbies, but the government was keen to show it was taking global warming seriously after months of massive “Friday for Future” protests.
The bill's approval also comes hot on the heels of European Commission chief Ursula Von Der Leyen's ambitious “Green Deal” unveiled earlier this month, aimed at making the bloc carbon neutral by 2050.
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Germany's climate package is estimated to cost the government €54 billion euros by 2023.
The slew of measures will see long-distance rail tickets become around 10 percent cheaper, while flying will become more expensive.
Following the compromise struck between the government and lawmakers, Germany will charge a starting price of 25 euros per tonne of carbon dioxide emissions in transport and construction from 2021.
The government had initially proposed a rate of just 10 euros per tonne – to the outrage of environmental campaigners, the opposition Greens and even members of Merkel's own coalition partner the Social Democrats.
The rate is set to increase to 55 euros per tonne by 2025, before eventually being incorporated into an EU-wide carbon trading system.
To offset the higher costs for consumers and companies, the climate package envisages subsidies for electric cars and tax incentives for greener heating, electricity and housing.
Merkel on Monday welcomed the carbon price compromise as a “positive contrast” to the lack of progress achieved at last week's inconclusive COP25 global climate conference in Madrid.
“The different parties… showed a willingness to tend towards a solution without letting things go on forever,” she said.
But academics from “Scientists for Future” said the CO2 price was “too weak” to convince households and companies to change their behaviour.
“It's too little, too late,” the campaigners said in a withering verdict of the climate package.
Winfried Kretschmann, a leading figure in the Green party and state premier of Baden-Wuerttemberg, struck a more upbeat note.
“It's a step in the right direction” but “many issues remain unresolved”, he said.
One of the most hotly-contested topics is Germany's planned coal exit by 2038, a controversial decision that has pitted environmentalists against those wanting to protect jobs in the sector.
The dirty fossil fuel still accounts for around a third of Germany's energy mix, in part because of Merkel's 2011 decision to phase out nuclear power.
Holger Lösch, deputy director of the Federation of German Industry (BDI) said Germany faced higher gas and electricity prices as a result of the climate package that would undermine the country's businesses.
By Kit Holden