The Tory-Liberal Democrat coalition suffered a major blow tonight as David Laws was forced to resign over expenses abuse allegations.
The Treasury Chief Secretary became the new Government's first casualty after it emerged he had channelled tens of thousands of pounds in public money to his long-term partner.
In a statement at the Treasury, Mr Laws said: "I do not see how I can carry out my crucial work on the Budget and spending review while I have to deal with the private and public implications of recent revelations."
In his resignation letter to Prime Minister David Cameron, Mr Laws wrote: "The last 24 hours have been very difficult and distressing for me, and I have been thinking carefully about what action I should take in the interests of the Government, my constituents and - most important of all - those whom I love.
"I am grateful for the strong support which I have received from my friends, family, and from you, the Deputy Prime Minister and the Chancellor.
"This support has been incredibly important, but nonetheless, I have decided that it is right to tender my resignation as Chief Secretary to the Treasury."
Responding to the resignation letter, Mr Cameron wrote: "The last 24 hours must have been extraordinarily difficult and painful for you.
"You are a good and honourable man. I am sure that, throughout, you have been motivated by wanting to protect your privacy rather than anything else. Your decision to resign from the Government demonstrates the importance you attach to your integrity.
"In your short lime at the Treasury, you have made a real difference, setting the Government on the right path to tackle the deficit which poses such a risk to our economy."
Lib Dem Danny Alexander will take over from Mr Laws as George Osborne's deputy at the Treasury, while Michael Moore will replace Mr Alexander as Scottish Secretary, Downing Street announced.
In his statement, Mr Laws insisted resigning had been "my decision alone", saying he was "extremely grateful" for strong support from Mr Cameron, Lib Dem leader Nick Clegg, and Chancellor George Osborne.
He also expressed heartfelt regret for putting his political career ahead of "those I love most".
"Most importantly, I have an overriding responsibility to those I love most, and who I feel I have exposed to scrutiny in this way," he said.
"I have pursued a political career because of my sense of public duty, but I have too often put this before the interests of those I love most. It is time to redress the balance.
"I want to apologise to my constituents for falling below the standards that they are entitled to expect from me."
The announcement came after a day of fevered speculation in the wake of the Daily Telegraph's revelations about Mr Laws' expenses claims.
According to the newspaper, between 2004 and 2007, Mr Laws claimed between £700 and £950 a month to sub-let a room in a flat in Kennington, south London, from his long-term partner, lobbyist James Lundie.
Mr Lundie sold the flat for a profit of £193,000 in 2007, buying another house nearby for £510,000.
The MP then began claiming to rent the "second bedroom" in this property. His claims increased to £920 a month. The partner also lived at the property. Mr Laws' main home is in his Yeovil constituency.
The arrangement continued until September 2009, when Parliamentary records indicate that Mr Laws switched his designated second home and began renting another flat at taxpayers' expense. His partner remained at the Kennington house.
Since 2006, Parliamentary rules have banned MPs from "leasing accommodation from a partner".
Last night Mr Laws apologised and announced that he would "immediately" pay back the money in the wake of the Daily Telegraph's disclosures, as well as referring himself to the parliamentary standards commissioner.
The Yeovil MP also dramatically chose to "out" himself as gay, saying his actions had been motivated by a desire to protect his privacy rather than financial gain.
Lib Dem colleagues including former leader Paddy Ashdown and Taunton MP Jeremy Browne rallied round Mr Laws, praising his "brilliance" and warning against a "witch hunt".
But Labour MPs questioned whether he should stay in post, and Sir Alistair Graham, former chairman of the Committee on Standards in Public Life, suggested Mr Laws should step aside from his job while the matter was investigated.
Mr Laws had explained his use of expenses by saying he had not regarded Mr Lundie as his "spouse" under the technical definition in Commons rules.
"However, I now accept that this was open to interpretation and will immediately pay back the costs of the rent and other housing costs I claimed from the time the rules changed (in 2006) until August 2009," he said.
Mr Laws insisted that, despite having been in a relationship with Mr Lundie since 2001, the fact had been "unknown to both family and friends throughout that time".
"I regret this situation deeply, accept that I should not have claimed my expenses in this way and apologise fully," he added.
The loss of Mr Laws is a significant setback for the coalition. He was a pivotal figure in the negotiations between the parties after the inconclusive general election result, and impressed Conservative right-wingers with the vigorous way he has set about implementing spending cuts.
Mr Alexander, another key figure in coalition negotiations, will now be thrust to centre stage in the drastic programme of spending cuts being planned by the Government.
Shadow cabinet minister Ed Balls said: "Having worked with David Laws over the last three years, I am personally very sorry about what has happened.
"Danny Alexander is a highly curious choice as Chief Secretary to the Treasury given he was a leading proponent of Britain joining the euro in the last decade as part of the Britain in Europe campaign.
"I hope he now accepts he was wrong and this would have been a disastrous course for Britain to take.
"He and the Liberal Democrats now have the chance to take a different course to David Laws and stop the spending cuts this year which, at this delicate moment for all our economies, would hit growth, jobs and economic recovery in Britain and Europe."