Determined that such payments can no longer be seen as a "gift for life" or an "old pals act", he said patients and NHS employees, rather than doctors, will in future make up the majority of a reformed Committee on Distinction Awards.
Consultants said they welcomed any moves to make the distinction award system fairer and more open but denied that they saw the payment as a "right" or a "bolt-on perk".
The new committee will also be able to review consultants' awards on several grounds, including findings of the General Medical Council, criminal convictions and disciplinary action.
Under the current system, once consultants are given an award, they receive it every year until they retire.
More women and people from ethnic minorities will also be represented on the awards committee, which will be pared down from 33 to 14 members. Consultants who show commitment to the NHS, providing high quality care in hardpressed areas, will also have their achievements recognised.
The Government said yesterday's proposals were "interim" measures and a more fundamental review of the awards scheme will be made next year. It has taken the action in the light of the row over nurses' pay and as part of its modernisation of the NHS.
But it is also believed to have been influenced by the Bristol baby heart scandal. James Wisheart, one of the consultants involved who has since been struck off, had been paid a bonus of pounds 54,910 on top of his NHS salary for services to medicine.
There have been concerns about how the merit awards are decided. In March it was revealed that while 13.9 per cent of NHS consultants are from ethnic minorities, only 6.2 per cent hold an award. Earlier protests about sex discrimination led to a slight increase in the number of female consultants gaining awards.
"Since the scheme costs the NHS over pounds 100m a year it must command public confidence," said Mr Milburn. "It needs to modernise in response to the criticism that it is part of an old pals act which does not bestow awards fairly."
He said the rewards had to be earned. "In the future poor performance, outright failure and inappropriate conduct will result in the immediate removal of awards," he added. "We will reward excellence. But we will ensure that the taxpayer does not end up rewarding failure."
The health union MSF said the ending of the system was "long overdue". Roger Kline, for the MSF, said: "The public need to know that merit awards are justified and fairly distributed."
Malcolm Curnow, speaking on behalf of the Bristol Heart Children's Action Group, said the proposals were "a clear indication" that the Government had acted upon what his members had been telling it.
Winston Peters, president of the Hospital Consultants Association, said: "The merit awards aren't some last bolt-on perk - they are an integral part of the consultants' pay structure and they are subject to a review body's decision."
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