Civil servants made redundant will have their payouts capped at one year's salary under plans announced by Cabinet Office minister Francis Maude.
He also said the maximum on offer for those taking voluntary redundancy would be limited to 15 months' salary.
Unions have threatened strike action, describing the proposals as "absolutely outrageous".
Mr Maude said the measures were "an inevitable consequence of current economic circumstances".
He said current arrangements - in which some senior civil servants were eligible for severance packages equivalent to six years' pay - were completely "untenable".
On average, civil servants receive pay-offs worth three years' salary under its current redundancy scheme, the Cabinet Office said.
Mr Maude urged unions to begin negotiations on putting together an "affordable" compensation scheme for the future which "enables us to move forward in these very difficult financial circumstances".
The PCS union, the largest union representing civil servants, sought legal action to block a cap at twice annual salary proposed by the previous government.
It said it was "absolutely outrageous" that the new government was trying to "get around" a High Court ruling which upheld the union's position that its members' terms and conditions could not be changed without their agreement.
"They are hard-pressed public servants whose jobs have never been more under threat," PCS general secretary Mark Serwotka told BBC Radio 4's World at One.
"We think it is right to defend people's contractual entitlements. There will inevitably be industrial action if jobs are cut, if pay is frozen, pensions are reduced, and now if our contractual terms are ripped up.
"People need to understand that the great majority of those affected are low-paid front-line staff who are being asked to pay a terrible price, in terms of their conditions and jobs, for a crisis they did not make.
The union said thousands of jobs had been lost across the civil service in recent years and it was a "myth" that civil servants were overpaid and enjoyed handsome pension benefits.
According to the union, 40% of their members earn less than £20,000 a year while the average salary in the civil service is £22,850 - £2,000 lower than the equivalent figure in the private sector.
The First Division Association, a separate union which backed Labour's proposals earlier this year, said the one-year cap on compensation now proposed "was significantly out of step" with the rest of the public sector.
"There will be anger and consternation at today's announcement," its general secretary Jonathan Baume said.
In a letter to the Council of Civil Service Unions, Mr Maude said the proposed steps were "necessary" due to the PCS union's "unilateral action in contesting the previous government's scheme".
While ministers were unlikely to give ground on the caps for compulsory redundancy payouts, he said there was scope for negotiation in other areas - including the terms of compensation to those taking voluntary redundancy - to agree a "fair and practical settlement".
"We really want to sit down with the civil service unions to say can we quickly get together and start to talk about how we give proper protection to low-paid workers so this is fair and is seen to be fair," he told the World at One.
The BBC's political correspondent Mike Sergeant said the proposals - which under Labour were approved by other unions - were politically explosive.
He said the PCS saw the plans as an assault on its members' rights at a time when public servants were seeing their pay frozen and their pensions reduced in value.
The Office of Budget Responsibility has estimated 600,000 public sector jobs could be lost as part of far-reaching spending cuts designed to reduce the budget deficit.
The government says it cannot rule out compulsory redundancies in the civil service but will try to avoid them.