The blast took place about 50 yards from the police station in an area packed with shoppers preparing for Iftar, the daily meal at which Muslims break their sunrise-to-sunset fast during the holy month of Ramadan.
Kamil al-Khazraji, the 33-year-old owner of a clothing store, said he was preparing to close when he heard the explosion.
"The ground under me was shaking. I went outside the shop only to see fire and dust all over the place," he said. "The area looked like a battlefield, with wounded people crying for help and scattered dead bodies."
Two police officers and a hospital official gave the casualty toll on condition of anonymity because they weren't authorized to release the information.
One of the officers said four policemen were among the 32 dead.
The U.S. military confirmed a car bomb exploded about 6:20 p.m. in Dujail, but said 23 Iraqis were killed and 40 others were wounded. Conflicting tolls from explosions in Iraq are common as authorities struggle to recover victims and contain the damage in the aftermath.
The death toll reported by Iraqi officials makes Friday's blast the deadliest since July 28, when 32 people were killed by three female suicide bombers who struck Shiite pilgrims in Baghdad.
Dujail, 50 miles north of Baghdad, was the site of a 1982 assassination attempt against Saddam Hussein. The ousted Iraqi leader was hanged on Dec. 30, 2006 after being convicted of ordering the killings of more than 140 Shiites from Dujail in retaliation for the attempt on his life.
More recently, Dujail has escaped major attacks and rigorous security measures common elsewhere in Iraq.
Earlier Friday, a suicide bomber blew himself up in front of a Shiite mosque farther north in Sinjar as worshippers left prayers at midday, killing two civilians and wounding 15, police chief Col. Awad Kahlil said.
Sinjar is near Mosul, which is the target of an ongoing U.S.-Iraqi operation against Sunni insurgents.
In political developments, Shiite followers of anti-U.S. cleric Muqtada al-Sadr demonstrated in Baghdad and the southern city of Kufa against plans for a U.S.-Iraqi security agreement that will determine the status of the U.S. military in Iraq after the current U.N. mandate expires at the end of the year.
In Baghdad's Sadr City neighborhood, Sheik Abdul Hadi al-Mohammadawi, an al-Sadr aide, told worshippers during prayers that it is a "suspicious agreement" that would bring "humiliation and degradation to the Iraqi people."
After the prayers, worshippers burned American and Israeli flags and chanted: "No, America, no! No, agreement, no!"
U.S.-Iraqi talks on the security agreement have slowed over Washington's insistence on retaining sole legal jurisdiction over American troops in Iraq and differences over a schedule for the departure of the U.S. military.
Iraqi officials want all foreign troops out by the end of 2011. However, President Bush has resisted a firm timetable for withdrawing troops from Iraq.
Associated Press writer Saad Abdul-Kadir in Baghdad and AP researcher Julie Reed in New York contributed to this report.