Seventeen residents of the town of Taza were being treated following a rocket attack launched on Wednesday from Bashir, south of the city of Kirkuk, medical sources said.
Kurdish peshmerga forces and Shiite militias are deployed in the area but a military push to flush out IS jihadists from some pockets has not materialised.
"30,000 people in Taza are under daily shelling and the government is silent," read a banner carried by one of the protesters blocking the road between Baghdad and Kirkuk.
"We demand Iraqi air force strikes on Bashir," chanted some people in the angry crowd.
According to Taza mayor Hussein Abbas, the town was struck by around 45 rockets over a period of three hours.
Several local officials said chlorine was used but samples were still being analysed to determine the exact nature of the chemical attack.
"The gas was a light silver colour and sometimes left some liquid where it landed," a senior security official said on condition of anonymity.
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"A specialised unit took some samples that are being analysed," he added.
Burhan Abdallah, who heads the Kirkuk health directorate, said 200 people had been treated since the attack.
"Most of them have been discharged. Only 17 are still in care. One of the them is a child in serious condition," he said. "They suffer from respiratory problems, burns and rashes."
Bashir, a majority Shiite Turkmen town just south of Taza, is under IS control, despite being visible from the highway.
It lies in an area that is officially under federal administration but is controlled by Kurdish forces that de facto expanded their autonomous region on the back of the jihadists' 2014 offensive.
Tension has been high between the peshmerga and Shiite militias in the area, impeding military cooperation against IS.
The governor of Kirkuk, Najm al-Din Karim, said that while Bashir may appear to be an easy military target, its liberation requires anti-IS forces to be on the same page.
"The issue of Bashir's liberation needs a decision that should be made by Prime Minister (Haider al-Abadi), coalition forces and the brothers of the Kurdistan Regional Government," he said.