The previous parliament voted in its dying days in September to end the system of mayors, provincial governors and district heads being chosen by the public in the world's third-biggest democracy.
Instead, local parliaments were given the power to pick them - a move widely criticised as an attack on the process of democratisation started after the downfall of long-serving dictator Suharto in 1998.
It was also a blow to Widodo, who backed local polls, just weeks after he was elected Indonesia's president from outside the political and military elites, and was seen as revenge by opponents still hurting from defeat in the vote.
Following the vote, outgoing president Susilo Bambang Yudhoyono, who was criticised for allowing the bill to pass, issued a decree to reverse the decision.
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That decree only stayed in force for several months. But today, lawmakers in the lower house voted to make it a permanent law and maintain direct elections.
Home affairs minister Tjahjo Kumolo said the decision was aimed at "upholding sovereignty and the democratic spirit of the people".
Analysts said that the decision was a boost for Widodo, who was elected in July and took office in October, and was a sign his coalition would be able to get much-needed reforms through parliament.
"It shows the ruling coalition has the upper hand," said Tobias Basuki, a political analyst from Jakarta-based think-tank the Centre for Strategic and International Studies.