Second reading passes by one vote with NZ First withdrawing support and questioning whether reforms fair.
Sweeping changes to the welfare system came closer to passing into law despite losing the support of New Zealand First and official advice that the changes would lead to a decline in poor families' health.
After a fiery, personal debate in which Opposition members accused former beneficiary and Social Development Minister Paula Bennett of "kicking away the ladder", the reforms passed their second reading 61 votes to 60.
New Zealand First reversed its previous support for the bill.
MP Asenati Lole-Taylor said New Zealand First supported the intention of moving more beneficiaries into work but questioned whether the reforms were fair or effective.
The Social Security Amendment Bill would reduce the number of benefit categories and put greater emphasis on finding work, cut benefits for people who failed or refused pre-employment drug tests, and cut welfare for people who turned down a job or had an outstanding arrest warrant.
The legislation would also create new social obligations by requiring beneficiaries with dependent children to take all possible steps to enrol under-5-year-olds in early childhood care and a health clinic.
Ms Bennett said that despite "hand-wringing" by the Opposition and claims of beneficiary bashing, National campaigned on the changes in 2011 and was overwhelmingly supported by New Zealanders.
She said: "This Government does not see people on welfare as victims but as individuals who with the right support can, in most cases, have a better life in work and off welfare.
"For those who simply cannot work due to severe illness or disability, we will continue to support them with dignity."
Responding to arguments that a stronger job market - not punitive measures - were required to help beneficiaries, she pointed to her party's assistance to employers such as the 90-day trial period and proposed youth wage.
But Green Party co-leader Metiria Turei pointed to Ministry of Health advice, released under the Official Information Act, which warned ministers that the economic benefits of the changes could be undermined by health impacts. Families who were sanctioned were likely to defer healthcare and increasingly show up in emergency departments instead of primary care.
The ministry also warned that making Well Child checks compulsory for beneficiaries' children could change the relationship between families and health providers and make the system less effective.
The debate in the House was often heated, with Labour social development spokeswoman Jacinda Ardern attacking Ms Bennett for cutting benefits she once relied on.
The minister had earlier told MPs she had "never forgotten where she came from".
She was also told off by the Speaker for again calling her opposite number, Ms Ardern, "sweetie".