People voting in local elections could be offered entry to a free lottery under plans to increase turnout.
The report sets out 61 proposals to transform local councils.
The voting age could be dropped to 16 and pay and perks for councillors could be boosted in a bid to encourage people to participate in local democracy.
The independent Councillors Commission also wants "parachute payments" for council leaders who lose their seats - plans apparently opposed by ministers.
Communities Secretary Hazel Blears called the report "genuinely radical".
Currently, leaders of Britain's biggest town halls, who earn up to £60,000 a year as elected politicians, lose their salaries the day they are voted out of office.
But the Councillors Commission argues that there should be "parachute payments for elected mayors, leaders and executive portfolio-holders who lose office through the action of the electorate".
'Five term limit'
It recommends the cash payouts should be equivalent to redundancy money and linked to the amount of time in office.
Councillors should be able to receive local government pensions, while centrally imposed restrictions on pay for middle-ranking politicians should be removed, the report says.
It also suggests that some councillors could be able to claim unemployment benefit to top up their earnings and proposes a "communications allowance" to fund public relations material.
But politicians would be prevented from serving more than five terms in office, meaning that hundreds of experienced councillors could be swept out.
Male - 69.3%
Female - 29.3%
Aged 45-59 - 34.2%
Aged 65+ - 31.8%
Under 25 - 0.3%
White - 95.9%
Asian - 2.8%
Black - 0.5%
Degree/higher education qualifications - 49.8%
No qualifications - 14.9%
The commission says councillors are increasingly failing to reflect the communities they serve, with the average age for a councillor being 58.3, compared with 55.4 10 years ago, and the overwhelming majority are retired or self-employed.
Just 3.5% are under 30, fewer than one in three are women and only 4.1% come from ethnic minority backgrounds.
The commission supports calls for electoral reform, saying that the voting age should be reduced to 16, although registering on the electoral roll should remain voluntary for youths.
"Allowing young people the choice of voting at 16 would give them a personal stake in citizenship at a time when they were studying the subject at school," the report says.
'Revitalise' local democracy
Dame Jane Roberts, who chairs the commission, said: "The commission believes we should incentivise voting and local authorities should be able to develop and use creative schemes to encourage voters to turn out to vote.
"One of the ways of doing this would be to offer voters a chance to enter into a lottery."
The commission also proposes that councils should be given the option of introducing proportional representation.
Communities secretary Ms Blears said: "Today's independent report has come up with genuinely radical ideas to improve local democracy and representation."
She added: "There are still far too few councillors that are women, young, disabled or from an ethnic minority. I will look carefully at the recommendations for all political parties to do better, and the role that the Equality and Human Rights Commission can play.
"The vast majority of councillors make a vital contribution to public life, but I will also explore the recommendation on 'clawing back' allowances where there are serious concerns about their performance."
Shadow communities secretary Eric Pickles said: "Councillors have a valued role to play in holding town halls to account and making sure that councils deliver good quality, responsive frontline services.
"But it is vital that councillors are fundamentally arms-length volunteers - and do not become the bankrolled staff of the town hall dependent on the municipal pay packet."
Tom Brake, the Liberal Democrats local government spokesman, said the report showed the need to "revitalise" local democracy.
He said: "The commission is absolutely right to recommend fair and proportional voting. Making our councils more representative is a vital step in restoring faith in local democracy.
"Our current system discriminates against 16-year-olds who can work, pay taxes and join the armed forces, but are banned from voting.
"The government needs to listen to these concerns and give 16-year-olds the vote."
Sir Simon Milton, chairman of the Local Government Association, said it would be debating the proposals.
"More people would vote at council elections if local authorities had powers to raise and retain more money locally," he said.
"The commission has put forward a raft of innovative and challenging proposals and has taken an incredibly broad view of the sector."
However, it is understood that ministers are unlikely to take forward plans for parachute payments.