Controversial plans to establish foundation hospitals are to form the flagship of the government's drive to reform the health service.

The plans, championed by health secretary Alan Milburn, will see the best-performing hospitals rewarded with extra financial freedoms.

Rewarding the best-performing hospitals in England remains central to the government's drive to reform the huge NHS bureaucracy, ministers said on Wednesday.

With all the opposition parties committed to ending the centralised NHS bureaucracy by one means or another, the government is determined to rebut suggestions that it is seeking to micro-manage local hospitals by Whitehall diktat.

The plans will "devolve power and resources to frontline staff" - allowing doctors and nurses to take more decisions about service delivery.

However, critics have said that having abandoned the "internal market" introduced by the previous Conservative administration, Labour is setting about creating its own "two tier" health service.

"Nothing in the Queen's Speech suggests that the government understands the scale of the crisis facing the NHS or has any idea about how to tackle it," said shadow health secretary Dr Liam Fox.

He attacked the "completely ill thought out approach to foundation hospitals".

"Medical professionals' morale is at an all time low. Huge spending rises are failing to make any impact on the problems patients endure every day," he added.

Foundation hospitals will be able to decide their own financial and clinical priorities, with the possibility of being allowed to pay extra to staff and sell off land to raise money.

The trusts will be accountable to their local communities, with council leaders, business and patient representatives having a voice in how the hospitals are run.

The first of the newly empowered trusts are predicted to be operating in shadow form by April, becoming fully independent by the end of the 2003 as the legislation takes effect.

Dave Prentis, general secretary of Unison, said: "If we have hospitals acting outside of the NHS it sets up this two-tier system and will have a negative effect on recruitment and retention of staff from hospitals that don't have this kind of status."

The Royal College of Nursing said there was a danger of creating a two-tier system.

"Foundation hospitals must commit to the provision of a comprehensive, wide range of healthcare services, not just services that are financially profitable," said a spokesman.

Representatives of doctors and hospital managers were more welcoming, arguing that the reforms should even go further.

Gill Morgan, chief executive of the NHS Confederation, said: "We believe that foundations could be one way of releasing hospitals from Whitehall control, and a first step towards a more decentralised NHS.

"But they must not distract from the more far-reaching government commitment to a wide ranging programme of deregulation for all hospitals, not just the top ten."

Dr Ian Bogle, chairman of the British Medical Association, echoed that view, saying foundation hospitals would offer an "escape from unnecessary bureaucracy, and an unfettered ability to develop new ways of delivering better patient care".

But he called for the reforms to be extended to all hospitals.

Other measures in the health and social care bill will establish a new inspectorate to monitor performance and standards in both the NHS and the private sector.

There will also be provisions to allow for a new contract between the health service and GPs, and measures to allow primary care trusts to take responsibility for dentistry.

Other plans, currently being consulted on, could allow the NHS to recover treatment costs where people receive personal injury compensation for accidents and injuries.