Both some consumer and airline groups criticised the proposals, drawn up to take account of exceptional situations like the eruption of Icelandic volcano Eyjafjallajokull volcano, which stranded millions of people and cost airlines €1.3 billion.
The ash cloud released by the volcano closed European air space for six days in April 2010, and airlines paid one a half times the compensation they would normally pay in a year in just a week.
"Under current rules, air carriers must provide refreshments, meals and accommodation for an indefinite period of time, potentially threatening their financial survival," the Commission said in a paper outlining the proposal.
"We know that the real priority for stranded passengers is just to get home," Siim Kallas, the EU commissioner for transport, said in a statement.
The Commission also proposed that passengers be allowed to claim compensation only once flights are delayed by five hours for all intra-EU flights and short international flights of less than 3,500 km. The propoals must be approved by the European Parliament and EU Council.
The European Court of Justice ruled last year that passengers should be able to claim compensation for three-hour delays, unless they were caused by circumstances beyond the airline's control.
The Commission also said transport strikes should count as extraordinary circumstances, in which airlines would be liable for providing compensation.
Consumers, airlines not happy
The BEUC consumer organisation said it was disappointed that accommodation was capped at three nights and that compensation would only be available after five hours.
"Passengers are often left in limbo and without the support they should be entitled to," said Monique Goyens, the head of BEUC.
Airlines had feared that a landmark court ruling in another compensation claim, against Ryanair in January, would pave the way for bigger payouts to customers and raise fares.
The court ruled that airlines were obliged to provide care, even in "extraordinary circumstances" such as the ash cloud.
Ryanair, Europe's leading no-frills airline, was taken to court after refusing to compensate Denise McDonagh for €1,129 she spent on meals, accommodation and transport when her flight was cancelled because of the volcanic ash.
The Commission's new proposal also establishes that a passenger may not be denied boarding on the return leg of a ticket because they did not take the outbound flight.