The Veracruz state government said the decision is part of an effort to root out police corruption and start from zero in the state's largest city.
State spokeswoman Gina Dominguez said 800 police officers and 300 administrative employees were laid off. At a press conference, she said they can apply for jobs in a state police force, but must meet stricter standards for an agency with officers "who are better trained and more committed and who can deliver under our current security circumstances."
Armed marines barricaded police headquarters Wednesday and Navy helicopters were flying above the city where 35 bodies were dumped in September. It was one of the worst gang attacks of Mexico's drug war.
The change was agreed upon Monday by Veracruz Gov. Javier Duarte and federal Interior Secretary Alejandro Poire.
Mexico's army has taken over police operations several times before, notably in the border city of Ciudad Juarez and the border state of Tamaulipas. But Veracruz becomes the first state to completely disband a large police department and use marines as law enforcers. There are about 2,400 marines in the state of Veracruz.
Dominguez said the Navy operations will last only until the state can train more of its own police. Duarte already had disbanded a police force in the state's capital of Xalapa, but in that case state agents immediately replaced city police.
President Felipe Calderon has pushed an ambitious process for vetting all of Mexico's 460,000 police officers. His administration allocated $331 million for 200 cities to train and re-equip municipal police forces.
Governors have complained they lack the resources to ensure their police forces are clean.
Veracruz is a common route for drugs and migrants coming from the south. It was first dominated by the Gulf Cartel, and then its former armed wing, the Zetas, took over after the two split. The state saw a rise in crime this spring after a government offensive in neighboring Tamaulipas scared drug criminals away to Veracruz.
But the dumping of the 35 bodies shocked Mexico as it turned the port into a battleground between the Zetas and a gang aligned with the Sinaloa Cartel, led by Joaquin "El Chapo" Guzman.