Workers face a drastic cut in how much compensation they can win in unfair dismissal cases but "fire at will" reforms are being officially abandoned, business secretary Vince Cable has confirmed.
Company bosses will, however, be given stronger legal protections to get rid of under-performing staff under a shake-up of employment laws.
The Business Secretary will announce that "no-fault dismissal" proposals made in the David Cameron-commissioned Beecroft Report are being dropped after a lack of support for the idea among the business community.
Cable has made no secret of his opposition to the recommendation, which many Tories backed, but aides were keen to stress the controversial proposal was being ditched because there was "no significant evidence" that it would help employers and insisted Conservative as well as Lib Dem ministers were behind the move.
In a statement published on Friday the government says:
The consultation will also propose reducing the Unfair Dismissal compensation cap, including the option of a cap of 12 months’ pay alongside an upper limit. Our proposed changes will give business certainty about the maximum possible liability in respect of an individual unfair dismissal claim (e .g. someone who is paid £20k cannot be awarded more than £20k).
The Business Secretary wants to bolster settlement agreements - where employers can offer under-performing employees a pay off - so they become more widely used to resolve disputes.
Under the proposals if the worker accepts the deal it will become legally protected so it cannot be used later as evidence in any court case or tribunal.
Officials insist the move is fair to employees as they are not obliged to take the package and also incentivises bosses to offer a good package, which can include a binding promise of a favourable reference.
Cable will also consult on plans to change the limit on unfair dismissal payouts to a maximum of 12 months' salary or set it at an even lower figure.
He wants to reduce the current £72,300 cap significantly in the hope of encouraging small businesses to start hiring more staff.
The Lib Dem believes the current cap deters firms, particularly small businesses, from hiring because they fear they could be landed with a big bill.
TUC General Secretary Brendan Barber said: "Reducing payouts for unfair dismissals will let bad employers off lightly and deter victims from pursuing genuine cases. This will feel like another slap in the face following the Government's decision to bring in fees for employment tribunals."
But the Federation of Small businesses described it as :"A balanced package of measures which will help to reduce the fear of taking on staff for small firms. It is good news that instant dismissal plans have been shelved. We were against this idea, believing it could create a two-tier labour market and be bad news for worker relations. "
Shadow Business Secretary Chuka Umunna said: "Ministers should be making it easier to hire, not easier to fire people. We are in a double dip recession due to this Government's failed economic policies, not because of the protections people have at work. Instead of adopting a credible plan for growth, this Government is attacking rights of every employee in this country.
"Sacrificing people's rights at work is not the way to bolster consumer confidence and get our economy moving again."
Cable said he was "trying to strike a balance" between helping employers and protecting employees.
He told ITV1's Daybreak: "People would feel intimidated if they knew that they could be fired on the spot without good reason and that is why we have said no to those proposals."
He added: "We don't want people to feel insecure, but at the same time small companies have got to feel confident that if they take somebody on they're not going to get caught up in a very elaborate, legalistic, time-consuming tribunal system."
Paul Kenny, GMB general secretary, said: "This is unlikely to create jobs as the overwhelming majority of employers do not think about the rights of employees when making decisions about employing more staff. Such decisions are influenced by factors like their confidence about future demand for their goods or services. Employers' confidence has been knocked sideways by this government stalling the recovery they inherited and the double dip recession.
"In fact the steps being taken here by government, and the 'noises off' about it being easier to sack people, will have a much more profound effect on workers than employers. It will increase feelings of job insecurity and reduce the confidence of workers as consumers to commit to spending.
"Therefore it will have a dampening effect on consumer demand which will in turn further weaken the confidence of businesses who consequently will not take on workers.
"The policy will have precisely the opposite effect on jobs than the stated intention of the Government. So as well as being wrong in principle to weaken employment rights it also makes no sense in a weak economy to create uncertainty among workers as consumers that will stop them spending."
Chris Keates, general secretary of the NASUWT said: "The Liberal Democrats should be ashamed to be associated with the introduction of measures which give employers licence to exploit, bully and discriminate against their workforce.
"However the Coalition seeks to spin this announcement, this emphasises the contempt for working people which pervades the Coalition's policies."