Chief secretary to the Treasury, Danny Alexander, said it would end the use of offshore payroll services in tax havens such as Jersey and Guernsey which have left around 100,000 people ineligible for some benefits.
The employees affected are mostly teachers, nurses and oil and gas workers.
Alexander said he was alerted to the loophole when he was approached by a fellow passenger at Inverness Airport, but he found that Her Majesty’s Revenue and Customs was already investigating it.
The chief secretary said that employers were evading tax and leaving their employees without benefits if they fall ill.
“It is not just about the tax we get in, it is also the case that many employees will not know they are paid in this way,” he told the BBC. “If their employer is not paying Employers National Insurance, unbeknownst to them, they may not then be entitled to statutory maternity pay if they become pregnant, they may not be entitled to statutory sick pay if they fall ill.”
Alexander will announce the measure when he addresses the Scottish Liberal Democrat conference in Dundee on Saturday.
His announcement was the first of a series of “leaks” of budget measures before the formal announcement on Wednesday.
It was also reported that George Osborne‘s budget on Wednesday would also contain details of a £1.5bn childcare scheme to help with nursery fees.
Families would get up to £2,000 in vouchers under the initiative, though it may not start until 2015.
In an interview with the Daily Telegraph, Balls said temporary borrowing to fund a cut in the basic rate of income tax would pay for itself.
Labour has proposed a temporary VAT reduction as the best way to stimulate recovery but Balls said he would “applaud” any any type of tax cut.
“Something must be done now … you need some fiscal action,” he said. “If George Osborne announced a temporary cut in the basic rate we would applaud him because we would say, ‘At last he is finally doing something to get some spending power back into the economy.'”
Osborne is under pressure from the Tory right to make bold tax moves on Wednesday to encourage economic growth in the UK. The prospect of a triple-dip recession and the recent loss of the UK’s AAA credit rating have heightened demands for a change of course.
But the chancellor is expected to maintain his tough austerity programme, with the prime minister, David Cameron, declaring the budget would be about “sticking to the course”.