In what he branded the "local tax lock", Communities Secretary Eric Pickles promoted his proposal as a measure to help hard-working families.
But Labour politicians in Nottingham and Westminster immediately branded the announcement as a "red-herring".
They claimed the Government was using it to divert attention from crippling cuts imposed on councils.
From April, if a council seeks to increase tax above the 3.5% limit, a referendum will be triggered. If the local electorate votes against the increase, the council must revert to a lower council tax level.
But Nottingham East MP Chris Leslie said: "This is all a bit of a red herring because no one would really want to see council tax rising above that level anyway. It's just an attempt on his part to look strong.
"What he should be doing is explaining the massive cuts in grants for the city that are going to hit people really hard."
The move has been welcomed by Councillor Georgina Culley, Conservative leader at the city council.
"People need to know if it's going to be a high increase, and they need to know why the council feels it's justified in going beyond a 3.5% increase," she said.
Mr Pickles said: "Since 1997 people have seen their council tax more than double, pushing typical bills to £120 a month.
"We are getting to grips with this with another council tax freeze deal and by radically extending direct democracy over big bill increases with a new local tax lock."
The announcement came on the day that Deputy Prime Minister Nick Clegg confirmed the Government would seek to devolve new powers to Nottingham City Council and authorities in England's seven other biggest cities.
These included measures to give local authorities a greater say over transport investment, more control of business rate receipts and the ability to grant firms a tax discount.
Mr Leslie said: "This is blatant centralism rather than any sort of serious attempt to delegate local decisions to local authorities."
George Cowcher, chief executive of the Derbyshire and Notts Chamber of Commerce, said it could have a positive impact on businesses.
But he said: "In order to make this work, it is absolutely crucial that business is placed at the centre of any decision-making processes, along with local control of transport and training in order to create a better environment for private-sector growth."
Mrs Culley hoped that if councils were given more freedom to spend money, that more money and decisions could be devolved to ward councillors.
