The government is promising to "make work pay" as it sets out plans to ensure people in work are better off than the unemployed.
A "universal credit", sanctions for those turning down jobs and a cap on benefits paid to a single family are among the changes outlined.
Planned housing benefit curbs for the jobless have been dropped but tenants 'under-occupying' homes face cuts.
Labour backs some changes but says help for people to find work is inadequate.
The changes, outlined in the Welfare Reform Bill, include:
- A single universal credit to come into force in 2013
- Tax changes to enable people to keep more income
- Changes to the disability living allowance
- More details of the back-to-work programme
- Those refusing to work facing a maximum three-year loss of benefits
- Annual benefit cap of about £26,000 per family
- Review of sickness absence levels
Central to the plan is the creation of a universal credit, a process which will begin in 2013 and continue into the next parliament.
The government says, with five million people of working age on out-of-work benefits and 1.4 million of those for nearly a decade, that unemployment has become entrenched in many communities.
Prime Minister David Cameron said the bill would "bring about the most fundamental and radical changes to the welfare system since it began".
He added: "Never again will work be the wrong financial choice... We are finally going to make work pay for some of the poorest people in our society."
Work and Pensions Secretary Iain Duncan Smith said: "Our reforms will end the absurdity of a system where people too often get rewarded for doing the wrong thing, and those who strive to do the best by their families get penalised.
"The publication of the Welfare Reform Bill will put work, rather than hand-outs, at the heart of the welfare system."
Asked about dropping the plan to reduce housing benefit for the long-term unemployed, Mr Duncan Smith told BBC Radio 4's Today programme it would "not be" in the bill.
He said: "Nobody will be worse off [under the changes]. They will be cash-protected."
Mr Duncan Smith also said: "The universal credit will make sure that the poorest in society will be better off."
The universal credit will see existing out-of-work and in-work entitlements, such as Jobseeker's Allowance, Income Support and Housing Benefit, paid as a single lump sum although it is unclear how many benefits will be included in the new payment.
Ministers believe this will make it easier for them to demonstrate the value of being in work, reduce administrative costs and the risk of fraud.
They argue that the current system actively discourages claimants from looking for work, or those on low-paid jobs from increasing their hours, as rates of tax and benefit reductions leave them worse off.
In future, the government is guaranteeing that for every £1 extra people earn, they will be at least 35p better off as a result of being in work.
Up to 2.7 million households will be better off as a result of the changes, ministers say, with more than a million of these - including many of the poorest - seeing an increase of £25 a week.
But the Institute for Fiscal Studies has warned that while the changes could benefit 2.5 million households, a further 1.4 million - including many lone parents and families with savings of more than £16,000 - face being worse off.
Ministers say transitional arrangements will be put in place to make sure no-one is worse off while they are being migrated to the new system - which will cost £2.1bn up-front to introduce.
That short-term cost, they insist, will reap considerably higher savings in the long term.
The government has dropped controversial plans to cut housing benefit by 10% for people out-of-work for more than a year - but the bill includes plans to cut housing benefit for tenants deemed to be "under-occupying" their homes.
The National Housing Federation attacked the move, claiming about 680,000 people living in local authority and housing association properties will lose some of their housing benefit, "with many people struggling to pay their rent and ending up being forced to leave their home".
Labour supports efforts to simplify the benefit system and back "conditionality" on benefits but says people should not be penalised for being unable to find work and the proposals do not provide a "panacea" for reducing unemployment.
"There is a big problem about a lack of jobs for people to move into," Shadow employment spokesman Stephen Timms said. "There just aren't the jobs there."
'Blaming the jobless'
Critics say the overhaul could leave vulnerable people worse off.
TUC general secretary Brendan Barber said: "Long-term unemployment has doubled not because of a sudden increase in work-shy scroungers, but as an inevitable result of economic policies based on cuts that destroy growth.
"Of course no welfare support is perfect and a small minority play the system, but just as conjurors divert your attention when doing a trick, today's proposals are based on blaming the jobless for their own unemployment in the hope that voters won't notice the real cause."
But Katja Hall, chief policy director at the Confederation of British Industry, said: "Getting the UK working is crucial for securing economic growth. We welcome the government's plans to get people off benefits and into long-term employment and to tackle long-term sickness."
Sam Bowman of the Adam Smith Institute, a pro-free market think-tank, said: "The government's welfare reforms are a good step towards reducing people's dependency on benefits, but they are only part of the story.
"The minimum wage prices the most unskilled and inexperienced out of work and it should be abolished if the welfare reforms are to have the impact the government hopes."
Kate Wareing, Oxfam's UK poverty director, said it was a "step in the right direction" but lacked detail, adding that the government needed to make sure the "safety net welfare provides is not being pulled from under our feet".
Gavin Poole of the Centre for Social Justice think-tank, which was founded by Mr Duncan Smith, said: "It [the bill] offers a once-in-a-generation opportunity to overhaul a dysfunctional and chaotic benefits system that locks people in poverty and stifles aspiration."