Chancellor Alistair Darling has put up the personal tax allowance by £600 - meaning anyone earning up to £40,835 will gain £120 this year.
His £2.7bn tax cut for this year came as part of measures to help those hit by the axing of the 10p tax rate.
He told MPs he would lower the level at which 40p tax is paid - so higher earners did not gain from the change.
Tory George Osborne accused Mr Darling of "cynicism". Lib Dem Vince Cable feared it was a "short-term gimmick".
The shadow chancellor said Mr Darling had been "humiliated" into coming to the Commons with "a mini-Budget to clear up the mess made by the prime minister in his last budget as chancellor".
"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," Mr Osborne said.
'Fairest way'
BBC political editor Nick Robinson said that the statement was effectively an "emergency budget" forced by fears that a Labour rebellion might see this year's actual Budget defeated in the Commons.
But Mr Darling claimed the change was the "fairest and most effective way" to help those who lost out from the scrapping of the 10p tax rate.
"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"
He said it meant 22 million people on low and middle incomes would gain an additional £120 this year.
The money will come via a £60 lump sum in September pay packets, followed by a £10 monthly increase until the end of the year.
Of the 5.3 million households which had lost out from the scrapping of the 10p tax rate, 4.2m will receive as much or more than they lost when the 10p starting rate of tax was axed.
Field apology
Mr Darling added: "The remaining 1.1m 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.
"And in addition, 600,000 people on low incomes will be taken out of income tax altogether."
Mr Darling, whose announcement was greeted with cheers by Labour MPs, said the measures would be funded through borrowing so as not to take money out of the economy while it was slowing.
The abolition of the 10p tax was widely seen as one of the key factors in Labour's poor showing in this month's local council elections.
Speaking to the BBC later, Mr Darling rejected criticisms that the measures were simply a political bribe ahead of the Crewe and Nantwich by-election on 22 May.
Further compensation
"The same political critics just three weeks ago were demanding that I come up with something - not in November, but now," he said.
"Now I said that I would need to take time to try and work this out, I took that time and I've come up with something that I think actually helps a far wider range of people than people thought possible."
Labour backbenchers had been calling for the chancellor to spell out the compensation package ahead of next week's crunch Crewe & Nantwich by-election.
Mr Darling said he would reveal his plans for further compensation beyond the current tax year in his pre-Budget report in the autumn.
Ex-minister Frank Field, who had led the rebellion against the scrapping of the 10p tax rate, welcomed the announcement and apologised for his remarks about the prime minister in a BBC interview on Sunday.
Mr Cable welcomed the measures to lift low earners out of tax. He told the chancellor: "It may well be that for a few hours this will get you out of the difficulties that you created for yourself."
HAVE YOUR SAY
John McFall, Labour chairman of the Commons Treasury select committee, said: "It is nothing but churlish and mean not to welcome a statement today that benefits everyone who is on basic rate taxation and takes 600,000 people out of tax altogether."
The unions also welcomed the chancellor's tax allowance changes.
GMB general secretary Paul Kenny congratulated Mr Brown and Mr Darling for "listening to the public and changing tack" while Dave Prentis, general secretary of Unison said: it was "a very welcome move".
Tony Woodley, joint leader of Unite, added: "Reconnecting with Labour's social conscience in this way is a major step towards reconnecting with voters generally."
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