Deanna Amato, a 34-year-old local government employee, found out Centrelink claimed she owed it a debt in January only after it had garnisheed her full $1,700 tax return.

The alleged debt of $2,500 dated back to her time receiving social security as a student in 2012 but Centrelink had sent repeated notices to an old address which Amato was under no obligation to update because she no longer received payments.

Centrelink did not contact her former employers or her bank to verify the alleged debt which was instead calculated using the controversial income-averaging method.

The central feature of the robodebt program since changes increased automation in 2016, income-averaging uses annual tax returns to estimate welfare recipients’ income across fortnightly periods in search of discrepancies. Centrelink then writes to people urging them to disprove or pay back the amount, in a process critics say reverses the onus of proof.

When Victoria Legal Aid intervened, the debt was reduced to $1.48 in September, leaving Amato “stunned” that it could be cleared up so easily when legal pressure was applied.

Then on Tuesday, just two weeks before Amato’s case is due to be heard in the federal court, the human services department abandoned the sole reliance on income-averaging to raise debts, an admission that the central feature of the automated system was broken.

It was just as welfare groups, legal centres, Senate inquiries and a former Administrative Appeals Tribunal senior member, Terry Carney, had warned: income averaging is not a proper basis to claim a debt.

But Amato’s case will continue, as will the class action supported by Labor and run by Gordon Legal, which has so far attracted 4,000 expressions of interest and was formally launched on Wednesday.

The shadow minister for government services, Bill Shorten, and Gordon Legal senior partner Peter Gordon. Photograph: Mick Tsikas/AAP

Peter Gordon says because of the opt-out nature of class actions in Australia, people will have a right to participate if they are captured by the group description so, if successful, the case could trigger refunds for hundreds of thousands of people whose debts were calculated with income-averaging.

It is unclear how much of the $660m raised by the program so far will have to be repaid, but the government services minister, Stuart Robert, has played down the significance of Tuesday’s changes, saying only a “small cohort” of robodebts are affected.

Human services staff have been told that up to 600,000 of the 900,000 robodebts that have been issued used income-averaging and will need to be reassessed and more than 220,000 may require refunds or waivers.

As well as seeking debts be waived on the basis the government had unjustly enriched itself, the class action argues it owed vulnerable welfare recipients a duty of care, a duty that was breached through threatening notices claiming a debt was owed. It seeks damages for stress, anxiety and stigma.

Gordon says his firm has been contacted by those “confident enough” to call lawyers, but the system has also “preyed upon some of the most vulnerable in society, people who are economically challenged, not familiar with the system or didn’t retain records or have the resources” to challenge unlawful debts.

The statement of claim reveals the case will be fought on behalf of people like a former youth allowance recipient, Elyane Porter, who had $804 garnisheed from her tax return and is being pursued for another $2,493.

Behind the dry details of disputed debts sit victims of the system, like Francine Wheeler who joined the class action to fight a debt she labelled “a horrible weight on my shoulders”.

“I don’t think that I owe them any money because I was honest at the time of reporting my income,” Wheeler says. “It’s been so difficult. Basically what happened was they did the review and in the time of them doing it, they just automatically garnisheed my tax return. Before they’d even sent me a letter confirming that.”

In June 2018 one man who told Guardian Australia he felt suicidal after months disputing an alleged $4,000 only to have to go through the ordeal again months later when issued another notice.

Trying to stand over a bereaved mum for a debt that in all likelihood never existed, that was sickening. Bill Shorten

One welfare recipient told a Senate inquiry that “you feel powerless to challenge Centrelink” because “they have the power of destroying your life, actually and literally”.

In October a Senate inquiry heard Centrelink issued a $14,500 robodebt to a disability pensioner with an intellectual impairment and then failed to offer him support to deal with the alleged overpayment.

Greens senator Rachel Siewert is struck by “the distress people feel” when they receive notices.

Siewert says Senate inquiries she chaired heard from “older people who have been heartbroken because they think they’ve been accused of trying to defraud the commonwealth, that people see them as cheating”.

And while some people are disputing very large amounts, for welfare recipients “on a small amount of money, even a couple of hundred of dollars scares people”.

Labor’s government services spokesman, Bill Shorten, says for him the “real low point was the experience of Anastasia McCardel being rung at home and grilled over her dead son Bruce’s alleged debt”.

“Trying to stand over a bereaved mum for a debt that in all likelihood never existed, that was sickening.”

Gordon cites examples of “massive hardship”, including those worried they would lose their jobs when employers are asked to garnishee wages, people who needed medicine to treat anxiety, who were “harassed” by debt collectors, or were told they may not be able to travel internationally by Australian authorities.

The future of the system that was to ramp up to 1m robodebts to achieve savings of $2.1bn is in doubt, but critics are asking how the government can claim not to have known this day would come.

The attorney general, Christian Porter – the former social services minister who refused to apologise when a Senate inquiry demanded the system be suspended – said on Wednesday that government legal advice in the cases before the courts “fed in” to changes announced this week.

He defended the automation of robodebts, telling ABC TV that “the legality of the scheme was underpinned by legal advice that was internal at the time”.

The attorney general, Christian Porter, said of the robodebt scheme that ‘the legality of the scheme was underpinned by legal advice that was internal at the time’. Photograph: Mick Tsikas/AAP

Departmental officials have explained that position is based on the claim the robodebt system does not reverse the onus of proof for recipients to disprove a debt, it merely highlights discrepancies.

But legal advice obtained in “an individual matter that’s been a recent matter” had prompted a rethink, Porter said. “When we receive advice that indicates something should change by way of process, I think we act reasonably, fairly and quickly.

“Where there are individual instances where that process has failed, as there are when you do something at very high volume, individuals should be the subject of an apology.”

Shorten says the government should release the advice to reassure the public “this was not cowboy hour”.

“Otherwise it would seem the only question the Liberals asked before unleashing this menace on vulnerable Australians is: ‘Can we get away with this?’”

The departmental email revealing the changes commits to review debts to find those solely based on income-averaging, but welfare recipients are still in the dark. Scripts provided to staff urge them to say the department will contact people if they are affected.

Centrelink will now seek more information, such as payslips, before claiming welfare recipients owe a debt.

Gordon says the government “hounded people for money it was not entitled to, and now it’s asking the country and these people to trust them to get it right”.

“We don’t trust this government to deal with [refunds] … Now it has conceded recovery was unlawful, it needs to pay the money back, and if it won’t we’ll get orders compelling it to.”