Chancellor Alistair Darling has announced £2.7 billion worth of help for low and middle income workers hit by the scrapping of the 10p income tax rate.
In a surprise move greeted by loud Labour cheers, Mr Darling told the Commons he will increase personal tax allowances by £600 this year, funding the handout through additional borrowing.
The change, backdated to April 6, will benefit more than 22 million workers to the tune of up to £120 and fully compensate four-fifths of the 5.3 million who lost out from the abolition of the 10p rate.
But 1.1 million of the lowest-paid workers - earning between £6,500 and £12,800 annually - will still be worse off, as the increased allowance is worth as little as half of their losses.
Mr Darling said it was "the fairest and most effective" way to help those who lost out from changes announced in Gordon Brown's last Budget as Chancellor last year which came into effect last month. The decision was welcomed by unions, while the leader of Labour's backbench tax rebellion, Frank Field, said it should "put an end to this issue".
But Conservatives described it as a "humiliation" and accused the Chancellor and Mr Brown of "panicking" ahead of next week's crucial by-election in Crewe and Nantwich.
Voter anger over the 10p rate was a key factor in Labour's mauling in the May 1 local elections and Tories have made it a central feature of their campaign to capture the Cheshire seat.
Mr Darling told MPs the one-off measure, to be introduced in the Finance Bill currently going through Parliament, will see personal income tax allowances increased from £5,435 to £6,035 this year, taking some 600,000 people out of tax altogether.
Treasury officials rejected Tory claims that the tax change amounted to a "mini-Budget", and declined to say whether the extra borrowing would breach the Chancellor's fiscal rules.
