James Purnell's determination to shrink the list of 2.6 million people on incapacity benefits might not be the policy launch that loses Labour the Glasgow East by-election, but it will be seen as the symbolic act that seals the Blair legacy and provides a first glimpse of what a Conservative government's welfare policy would look like.

Plans for pilot schemes that will pay private companies to get people on to welfare to work schemes, leaked to the media ahead of a green paper launch on Monday, had the Conservatives cheering what they claimed as their own idea and Labour's traditional supporters wondering where the party's moral compass had led them.

Work and Pensions Secretary Mr Purnell, seen as the young Blairite heir in cabinet, has been trailing his "work for dole" scheme for some time.

The green paper, to be launched on Monday, will detail how five city-wide pilot schemes to test "compulsory full-time activity" for the long-term unemployed will operate. Stripped of euphemism these terms herald the beginning of workfare in the UK.

The new rules, insisting there can be "no right to a life on benefits" for anyone capable of working, represent a complete acceptance of the recommendations from investment banker and government welfare adviser David Freud, who reported last year that up to two million people are unnecessarily claiming incapacity benefit.

His findings laid the groundwork for a draft paper that warns only disabled people "with the greatest needs" and full-time carers will be exempt from being expected to find work in future.

Among the new proposals are that drug users addicted to heroin or crack cocaine will have to attend treatment in return for benefit and that incapacity benefit will disappear by 2013, replaced by the Employment and Support Allowance and new medical assessments to determine claimants' capacity to work.

Those out of work and on Jobseeker's Allowance will be expected to make intensive efforts to find work within the first three and six months of unemployment. After a year the claimants will be transferred to a public, private or voluntary sector organisation to find them a job. The companies will be paid by government on their ability to get results.

After two years of unemployment those still on benefits will be expected to work for their dole in an echo of the US workfare schemes that will require them to sign on every day.

The government proposes legislation that will penalise those who refuse to take a job. Lone parents with children above the age of five and those on incapacity benefit may also be forced to take training for work.

The involvement of the private sector is only made possible by new accounting rules, previously opposed by the Treasury, that allow companies used to help people find jobs to be paid from resulting savings in benefits.

Mr Freud, whose advice has been acted on by the pensions secretary, claimed it would be "economically rational" to pay as much as £62,000 to a company which managed to place an incapacity benefit claimant in a job which lasted three years or more. Incapacity benefit costs the Treasury about £12bn a year.

The Tories called the announcement on the eve of the Glasgow East vote as courageous, code for foolish. The TUC described the idea as a "mistake".

Ann Begg, the Labour MP for Aberdeen South, said: "There are hard working people there in Glasgow East trying to do their best for their families.

"They pay taxes and expect people to make sure that people who can work do work."