The former Abbott government announced plans to increase the tax rate on working holiday makers from zero to 32.5 per cent in its 2015 budget.
Following more than a year of protest from the farming and tourism sectors, treasurer Scott Morrison has revealed a coalition compromise.
Starting January 1, 2017, backpackers will be taxed at a rate of 19 per cent instead, for earnings up to $37,000.
Earnings above that amount will be taxed at the same marginal rates as everyone else.
Working holiday makers will also save $50 when applying for a 417 or 462 visa, bringing the total cost down to $390.
The visa age of eligibility will also be extended from a maximum of 30 years of age to 35.
"We are not so precious as a government to think we can't improve on things," Treasurer Scott Morrison told reporters in Canberra this afternoon.
"These changes will lower the cost of coming to Australia for working holiday makers and leave them with more money in their pockets to be able to spend here in Australia in communities right across the country."
The change was backed by federal cabinet this morning, including Agriculture Minister Barnaby Joyce.
He told reporters in Canberra, "this is a vital part of the labour requirements that brings money back into the towns that brings money back into regional economies."
The National Farmers' Federation said the government's change of heart was a welcome win for the agricultural sector, which originally feared its vital temporary workforce would be decimated by a clear disincentive for backpackers to come to Australia.
The federal government will also set aside $10 million for Tourism Australia to help promote backpacker jobs down under.
In total, the tax backflip will cost the budget $350 million.
To help recoup the cost, backpackers will have to give back almost all of the superannuation they earn.
Travellers will also have to fork out an extra $5 every time they book a flight or ship overseas, through an increased passenger movement charge.
"We have now arrived at a package of measures which does protect the integrity of budget, and does address the concerns of the sector," said Scott Morrison.
The tourism sector has accused the government of treating its industry as a cash cow.
Tourism and Transport Forum chief executive officer, Margy Osmond, told reporters in Sydney this afternoon, "quite frankly it's unacceptable to make the industry now pay for what was a bad idea".
Opposition Leader Bill Shorten described the backpacker tax as a "mess from day one" but wouldn't commit to backing any of the proposed measures in the package.
Labor banked the revenue from the initial proposal in its election costings.
With AAP
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