Chancellor George Osborne has announced a fresh squeeze on benefits, as he admitted the UK economy was performing less well than expected.
Austerity measures will be extended to 2018 and Mr Osborne looks set to miss key debt-reduction targets.
He also announced more money for roads and schools and axed a planned 3p fuel duty rise, in his Autumn Statement.
He said "turning back now would be a disaster" for the UK. But Labour said his credibility was "in tatters".
Mr Osborne had said debt would start falling as a proportion of GDP by 2015/16 - the year of the next general election.
But he has been forced to delay that target by a year because of the worse than expected state of the economy, which is now expected to shrink this year by 0.1%.
The Office for Budgetary Responsibility says the UK has a "better than 50% chance of eliminating the structural current deficit in five years time", said the chancellor - meaning his other key objective has been pushed back by a year to 2017/18.
'In this together'
This move heralds a fresh benefits squeeze and a raid on the pensions of the wealthy.
Most working age benefits, such as Jobseekers Allowance and Child Benefit, will go up by 1%, less than the rate of inflation, for the next three years.
MPs are due to vote on the benefit squeeze, although Labour has yet to decide whether it will oppose the move.
"We need to see the detail," said the shadow chief secretary to the Treasury, Rachel Reeves.
"I just don't think it can be right to be cutting the support for those people on modest incomes and those people who through no fault of their own have lost their jobs"
And there will be a further cut in tax relief on large pension pots, saving £1bn a year - something the chancellor said proved "we are all in it together".
In other moves:
- Teachers' pay in England and Wales will be more closely linked to performance
- The go-ahead is given for 30 new gas-fired power stations
- An extra £1bn will be spent on road building projects, including the conversion of the remaining A1 dual carriageway from Leeds to Newcastle into a motorway
- The squeeze on benefits will lead to a reduction in the welfare bill of £3.7bn in 2015-16
- Plans to reduce council budgets in England are branded "unsustainable" by the Local Government Association
- A consultation is launched on easing the burden on companies of running final-salary pension schemes
- The private finance initiative (PFI) is to be made more public and less private
- The Lib Dems mistakenly issue a press release attacking Tory tax policies
Income tax personal allowances will go up by £1,335 - £235 more than previously announced - so no tax will be paid on earnings under £9,440.
The threshold for the 40% rate of income tax is to rise by 1% in 2014 and 2015 from £41,450 to £41,865 and then £42,285.
The basic state pension will rise by 2.5% next year to £110.15 a week.
- Autumn Statement in six minutes 06:29
- Osborne: Britain is on the right track 02:15
- Ed Balls: 'Worst-off paying the price' 01:06
- BBC editors' analysis 08:08
- Fuel tax rise 'cancelled' 01:00
- 'Employment set to go on rising' 00:56
- Chancellor on pension pots 02:02
- Below-inflation benefits increase 02:29
- Corporation tax cut 'advert for UK' 01:55
- 'More action' to tackle tax avoidance 02:02
- Road, rail and broadband plans 03:29
Mr Osborne announced a fresh crackdown on tax avoidance and a squeeze on Whitehall budgets to pay for a new road and school building programme.
He told MPs: "It's taking time, but the British economy is healing."
But Shadow Chancellor Ed Balls, for Labour, accused Mr Osborne of breaking his own rules, on which his credibility depended.
"Today after two and a half years we can see, and people can feel in the country, the true scale of this government's economic failure," Mr Balls told MPs,
He said the average family with children on £20,000 a year would be "worse off" - even with the personal allowance changes.
Mr Balls claimed Mr Osborne's plan to raise £1bn from pension tax relief on the well-off raised less than £1.6bn given away in Mr Osborne's first Budget on the same reliefs.
Office for Budgetary Responsibility chief Robert Chote said growth had been slower than predicted when the coalition came to power because of "disappointing" consumer spending, business investment and trade.
"What's striking has been the weakness of the recovery over such an extended period of time," he added.
Asked if this meant the government was no further forward in fixing the UK's economy than when it started, he said underlying structural problems had been worse than initially thought and he was now "less optimistic" about its long-term ability to bounce back.
A senior Liberal Democrat source described the Autumn Statement as a "good package" of measures in which the coalition had made "tough but fair" decisions.
CBI director general John Cridland welcomed the promised investment in infrastructure and new tax relief measures for small firms but said businesses now "need to see the chancellor's words translated into building sites on the ground".
"It is no surprise that after a difficult year the economic realities dictate that austerity and debt reduction will take longer," he added.
"The chancellor has stuck to his guns on deficit reduction - avoiding deeper cuts or more borrowing in order to retain international credibility."
Cuts 'not fast enough'
But TUC general secretary Brendan Barber said: "What is missing today is any vision of a future economy that can deliver decent jobs and living standards - it's pain without purpose."
He added: "When you are self-harming you should stop, not look for better sticking plasters."
Plaid Cymru MP Hywel Williams said the benefits squeeze set out in the Autumn Statement threatened to dismantle the welfare state and create a generation lost to unemployment, homelessness and poverty.
"Wales' higher-than-UK-average unemployment levels also show that the welfare of Welsh workers and jobseekers are low on the London priorities list," he said.
The SNP welcomed the "long overdue" extra capital investment promised for Scotland, but the party's Westminster leader Angus Robertson said Mr Osborne's "right wing pursuit of austerity" had wrecked the UK's economy.
"His response today has simply been to announce yet more austerity which will bear down extremely harshly on some of the most vulnerable people in society," added the MP.
But UK Independence Party leader Nigel Farage said Mr Osborne was "not cutting far enough or fast enough" and asked what had happened to the government's much-vaunted "bonfire of the quangos".
"We have got to make some big, deep cuts in these areas and I just don't think this government has the courage to do what needs to be done", he added.