Dutch Prime Minister Mark Rutte and his government resigned on Friday over a harrowing scandal that saw thousands of parents wrongly accused of child benefit fraud.

Rutte, one of Europe's longest serving leaders, said he would stay on in a caretaker capacity until elections in March to avoid disrupting the fight against the coronavirus pandemic.

The 53-year-old said the benefits system had gone "terribly wrong", with many innocent parents forced to pay back large amounts of money in child allowance and ending up financially ruined.

Some families were targeted for investigation by tax officials because they had dual nationality, underscoring longstanding criticisms of systemic racism in the Netherlands.

"The buck stops here," Rutte, the leader of the liberal VVD party, told a news conference after a meeting during which his four-party coalition cabinet unanimously decided they had to quit.

"The rule of law must protect its citizens from an all-powerful government, and here that's gone terribly wrong. Mistakes have been made that have resulted in great injustice to thousands of parents."

Rutte was booed as he cycled out of the government buildings in The Hague on his way to formally hand his resignation to Dutch King Willem-Alexander at the Huis ten Bosch Palace.

However opinion polls say Rutte's party would likely come first in the elections due on March 17, with the public still backing his handling of the coronavirus crisis, putting him in line for a fourth term in office.

Pressure had been mounting on Rutte, who was leading his third coalition government since coming to power in 2010, with the government facing a possible confidence vote next week.

A hard-hitting parliamentary investigation in December said civil servants cut off benefits to thousands of families wrongly accused of fraud between 2013 and 2019.

Many were required to pay back benefits totalling tens of thousands of euros (dollars). Reports said several couples had split up as a result of the strain.

The clamour grew after opposition Labour party chief Lodewijk Asscher, who was social affairs minister in Rutte's previous cabinet, resigned on Thursday over the scandal.

Rutte defended the decision to resign in the middle of a pandemic, with the Netherlands under its toughest Covid-19 restrictions yet and facing a surge in cases of a new variant first found in Britain.

Dutch Prime Minister Mark Rutte arrives for the cabinet meeting
Dutch Prime Minister Mark Rutte arrives for the cabinet meeting ANP / Remko de Waal

"Our fight against coronavirus continues," said Rutte, adding that the caretaker cabinet would "do what is necessary in the interests of the country".

Dutch far-right leader Geert Wilders, known for his strong stance against immigration and Islam, said it was "right" that the government had quit.

"Innocent people, were criminalised, their lives destroyed," Wilders said on Twitter. "It is not credible that officials should continue as if nothing had happened."

Green-Left party leader Jesse Klaver, another leading voice who had called for Rutte to resign, said the decision could be a "new start, a turning point" for the Netherlands.

Dutch media said some 26,000 people had been affected by the scandal.

Tax officials were also revealed to have carried out "racial profiling" of 11,000 people based on their dual nationality, including some of those hit by the false benefit fraud accusations.

The Dutch government announced at least 30,000 euros ($36,000) in compensation for each parent who was wrongly accused but it has not been enough to silence the growing clamour over the scandal.

Victims lodged a legal complaint Tuesday against three serving ministers and two former ministers including Asscher.

Several parents released a video calling for the government to quit and "Rutte resign" has been trending on Twitter since Tuesday.

The scandal has led to the downfall of a man nicknamed "Teflon Mark" for his ability to dodge political crises and awkward questions during his time in office.

His pragmatic leadership has guided the Netherlands through the global financial crisis and the coronavirus pandemic, but he has also been accused of pandering to the right on issues including immigration.

The plain-speaking Rutte is also a divisive figure in Europe due to his calls for more austerity and adherence to the rule of law.

Questions remain about what difference Rutte's resignation will actually make to the Dutch political landscape.

"I think it's mostly a symbolic gesture and I think it's a good symbolic gesture -- but in practice nothing really will change because the elections are coming up anyway," international relations student Jacco van der Veen, 26, told AFP in The Hague.