Basic rate taxpayers will have their tax bill cut by £120 this year after the government bowed to intense pressure to compensate those affected by the abolition of the 10p rate.

Chancellor Alistair Darling said personal tax allowances are to rise by £600 this year, with changes to the top rate threshold meaning higher rate payers will pay the same as now.

In a surprise move greeted by loud Labour cheers, Mr Darling told the Commons that the change would cost £2.7bn and would be funded by borrowing.

"This will mean that 22 million people on low and middle incomes will gain an additional £120 this year."

Mr Darling, who faced a Labour backbench backlash over the scrapping of the 10p tax band, said the change was the "fairest and most effective way" to help those who lost out.

The Chancellor has been under intense pressure from backbench rebels, led by former minister Frank Field, to come up with a compensation package for those hit by the ending of the 10p starting rate.

Mr Field was reported to have now apologised to the prime minister for his damning comments about Gordon Brown's future.

In a statement to MPs today, Mr Darling, flanked by the Prime Minister, said a rebate scheme would be too complex and expensive to administer.

Instead he wanted to help those on low and middle incomes as soon as possible by raising the individual personal tax allowance to £6035 this financial year, benefiting all basic rate taxpayers under 65.

Mr Darling said 4.2 million households will receive as much, or more than, they originally lost, while the remaining 1.1 million households will see their loss at least halved.

"In other words, 80% of households are fully compensated with the remaining 20% compensated by at least half.

"In addition, 600,000 people on low incomes will be taken out of tax altogether."

George Osborne accused Mr Darling of "cynicism" and "total incompetence".

"Let no-one be fooled why you are making this statement today - not because you wanted to.... but because this divided, dithering and disintegrating government are panicking in the face of the Crewe and Nantwich by-election," the shadow chancellor said.

Vince Cable, the Lib Dems' treasury spokesman said: "I hope this is not just another short-term gimmick."

Mr Darling said people aged between 60 and 64, whose average loss was £100, will get the advantage of increased allowance worth up to £120 and receive the additional £50 winter fuel payment for this year.

The increased allowance would apply to all income this year and be backdated to April 6.

From September basic rate taxpayers will see a one-off increase in their monthly income of £60 and then a rise of £10 a month for the rest of the financial year.

To focus help on low and middle income households, the Chancellor said he was reducing the threshold at which people start to pay tax at the higher rate by £600 to ensure higher rate taxpayers were "unaffected" by the rise in personal allowance.

The changes will be legislated for in this year's Finance Bill.

Mr Darling said the change would help all basic rate taxpaying families at a time when oil and food prices had been rising worldwide.

Proposals for next year would be set out in the Pre-Budget Report later this year.

He said it was "right and sensible" to allow borrowing to rise and investment to be maintained as the economy slowed.

"I am able to finance this proposal through borrowing this year ensuring that we do not take money out of the economy at this time."

Mr Darling added: "For future years our aim is to continue the same level of support for those on lower incomes and I shall bring forward proposals to do this at the Pre-Budget Report."