Social Security Secretary Alistair Darling announced the £60m package in the Commons on Tuesday following a review of the present compensation payment scheme.
The maximum payment will rise from £40,000 to £100,000.
Mr Darling said the current system under which claims had to be made within six years would be scrapped.
Instead, disabled people will be allowed to claim at any time up to the age of 21.
In addition, the "disability threshold" which people must cross before getting payments will be lowered from 80% to 60%.
People who have already received lump sums will receive top up payments ranging from £58,000 to £67,000.
Mr Darling said: "Nothing can make up for what has happened to these children, but we have a clear duty to support them and their families."
The Vaccine Damage Payment scheme was set up in 1979 to compensate babies who suffered mental and physical disability after being vaccinated against childhood diseases such as polio, whooping cough and measles.
Campaigners argued that the current scheme is now inadequate and has left many families suffering financial hardship.
Earlier this year figures showed 890 payments had been made under the 1979 scheme from a total of 4,000 claims.
The maximum payment was raised from £10,000 to £20,000 in 1985, to £30,000 in 1991 and to £40,000 in 1998.
Shadow Social Security Secretary David Willetts welcomed the statement, and said the Opposition would co-operate in progressing legislation at the earliest available opportunity.
However, he criticised the government over the length of time it had taken to produce the measures.
Labour MP Ian Stewart, chairman of the parliamentary group on vaccine damage, welcomed the announcement.
Speaking to BBC News Online, he said: "Since 1979, there have been around 900 successful claims. Some 800 of these were paid out at only £10,000.
"This decision will give those people, in particular, as much as £90,000. It will go some way towards helping families to secure best quality of life for those damaged by vaccines."
But Mr Stewart said pharmaceutical companies could help to boost the compensation scheme further.
"What I would like to see and what the all-party group would like to see is the pharmaceutical industry contributing to a 'no- blame' compensation scheme so that families do not spend years fighting their cases."