The move, though expected, angered Post Office chiefs and placed a question mark over the flotation of ICL, the computer services company leading the project.
The Horizon project, being developed by ICL Pathway as a way of curbing social security fraud, is three years behind schedule and an estimated pounds 300m over budget and is still only in operation at 250 out of Britain's 19,000 post offices.
In a statement last night, the Trade and Industry Secretary, Stephen Byers, said that the Government had decided to abandon plans to pay benefits at post offices using the electronic swipe card developed by ICL.
However, in what he claimed was a move to put the project "back on track", he said that ICL would continue with plans to computerise the Post Office Counters network by 2001 and claimed that savings in benefit fraud of pounds 100m would still be achievable.
The Post Office's chief executive, John Roberts, was said last night to be furious at the decision.
Post Office chiefs fear that the network will lose customers as more benefits are paid direct into banks, hitting revenues and putting hundreds of rural branches in danger of closure.
The fixed price contract with ICL Pathway will continue to run until 2005 but the terms will be revised so that payment is no longer linked to the volume of business transacted.