The attack happened in an open-air market in the village of Abu Sayda at about 2000 (1600 GMT) on Tuesday.
A police spokesman in the provincial capital Baquba said doctors at a local hospital believed the nature of victims' burns suggested poison gas.
Use of chlorine bombs has become more common since the start of the year, says a BBC correspondent in Baghdad.
Last month a bomb using chlorine and high explosive killed 35 people in Ramadi, west of the capital.
Chlorine - widely used as a cleaner and purifier in areas of poor water sanitation - is easy to obtain in Iraq.
Chlorine gas burns the skin on contact and can be fatal after a few breaths.
In February the United States military reported finding a bomb factory near Falluja, where chlorine car bombs were being constructed.
Diyala province - with its mixed Shia and Sunni Muslim population - has been the scene of frequent violence of a sectarian nature as well as attacks by anti-US insurgents.
Map highlighting the location of the Diyala Province.Insurgents in Iraq have used a chemical car bomb to kill at least 32 people and injuring at least 50 in the Diyala Province, in the village of Abu Saydah on Tuesday. Reports say that the vehicle used in the attack was parked at a market near two tea stalls.

"A small van with gas canisters exploded in a crowded market, there were many people dead at the scene," said Iraqi police officer, Captain Sadiq Mohammed.

According to police, the bomb was described as being filled with chlorine gas and injuries reported at the local hospital include burns from a "poisonous gas," but the United States military in Iraq denies those reports.
 
"Our folks on the scene... who are investigating this do not have any of those indications," said a spokesman for the U.S. military in Iraq, Lt-Col Michael Donnelly.

One of the injured, Kadim Hussein, who was taken to the Imam Ali hospital in Sadr City for treatment, complained of eye irritation. "My eyes became puffy due the chlorine gas that was packed in the car bomb...also I had many pieces of shrapnel in my chest and right shoulder," he said. 

Hospitals in Muqdadiyah and Sadr City received most of the victims of the bomb blast.  Doctors and authorities at the Imam Ali hospital reported that 11 of the patients they treated were presented with symptoms typical of chlorine poisoning and that many of the victims had trouble breathing. 

Chlorine can burn the skin almost instantly and can kill a person if they inhale too much of the fumes. Chlorine is usually used domestically as a disinfectant as well as a bleach.

In April, at least 35 were killed when insurgents detonated a chlorine bomb in the city of Ramadi.

This comes just 6 days after Army Maj. Gen. Benjamin R. Mixon, commander of the 25th Infantry Division based in Iraq's Diyala province asked for more troops to help with insurgents.