The move, which will be heralded as a new sign of Lib-Lab co-operation, could mean the death of the traditional voting system for the House of Commons before the next general election.
Lord Jenkins of Hillhead, the Liberal Democrat peer and ex-Labour Cabinet minister, will chair the commission of around half-a-dozen members including some who back neither party. It is expected to take between six and 12 months to report, making it possible for its recommendations to be implemented before the next election. A referendum will take place before any change.
The announcement follows a round of difficult negotiations over the remit for Lord Jenkins's commission. Tensions between the two parties remain after what one source described as a "fudge" . The Government has ensured that the Alternative Vote - the system favoured by many key Labour figures including the Minister Without Portfolio, Peter Mandelson - is not excluded from consideration.
That system, whereby if no one candidate gains 50 per cent support, the votes of the bottom candidates are redistributed, is not backed by the Liberal Democrats because it is not proportional.
Labour's election manifesto promised: "An independent commission on voting systems will be appointed early to recommend a proportional alternative to the first-past-the-post system."
One ministerial source said that Mr Blair had made it clear that "AV is very much on the agenda," adding that "the terms of reference will make clear that the commission can examine all voting systems".
Reference to the importance of proportionality in the remit is expected to be couched, with the words "broadly proportional" likely to be included.
Some Liberal Democrats argue even that wording excludes AV as an outcome, but other say that it will be for the commission itself to decide.
A likely compromise, floated last week by a senior Liberal Democrat, is an AV system with a "top-up" element to even out lack of proportionality.
Mr Blair still retains several options since, while he is committed to a referendum, he is not bound to endorse the findings of the commission.
But it he goes ahead with the referendum before the next election, and the voters back a new system, many believe it will be impossible to delay its implementation.
They argue that a general election under first-past-the-post would lack legitimacy if the voters had rejected the system.
On Monday the Liberal Democrats will meet John Prescott, Deputy Prime Minister, to discuss voting systems for the proposed new London authority and city mayor.
Mr Prescott is expected to back a first-past-the-post system for the authority, but AV for the mayor. The Liberal democrats will argue against first-past-the-post for any election.Reuse content