MPs have voted to suspend Derek Conway for 10 days and order him to return £13,161 of the money he paid his son.
The Tory MP has already been censured for overpaying Freddie's parliamentary allowances and has apologised to MPs.
The MP for Old Bexley and Sidcup has had his party's whip withdrawn and says he will not fight the next election.
The Commons commission's Nick Harvey said he opposed a full ban on employing relatives, but said that it should have to be declared publicly in future.
At the moment there are no rules against employing relatives paid for out of an MPs' allowances, and there is no requirement for any such link to be declared.
'Astonished'
Conservative MP Sir George Young, chairman of the Commons standards and privileges committee, welcomed Mr Conway's prompt admission of wrongdoing over the amount paid to his son, while he was a full-time student in Newcastle.
Sir George said the committee was "frankly astonished that after three years and a substantial amount of expenditure there was no independent evidence of his (Freddie Conway's) output or apparently anyone outside the family who had seen him working".
"It is difficult to think how much lower our collective reputation might sink"
Official guidelines suggested Freddie Conway should have been paid a basic salary of £16,640, based on his age and experience, but Mr Conway had disregarded this and paid him the "substantially higher" figure of £25,970, said Sir George.
Sir George hit back at criticisms that the Commons authorities had not come down hard enough on Mr Conway, saying judgements "can have serious and far reaching consequences for those who breach the rules".
'Reputation'
He said the committee had decided not to report Mr Conway's actions to the police and the question of whether MPs should be allowed to employ family members was a "debate for another day".
Commons leader Harriet Harman said it was a "highly regrettable" affair - her Conservative shadow Theresa May said Mr Conway's suspension was needed in order to protect the reputation of the Commons.
Labour former minister Frank Field said he thought there should be stronger sanctions and said it was "difficult to think how much lower our collective reputation might sink" in the eyes of the public.
Simon Hughes, for the Liberal Democrats, supported the call for Mr Conway's suspension and said MPs should be banned from employing more than one family member, that they should be recruited openly and paid the "going rate".
He also called for equal pension rights for "registered partners" of MPs as well as spouses.
'Distraction'
Later Mr Harvey, who sits on the Commons Commission, told the BBC that a regular "spot check" would help uncover "bogus arrangements" and said if MPs were to publicly register any relatives working for them, it could offer "reassurance".
However he said a total ban on children or spouses working for MPs was "not a runner" - nor was publishing the pay of people on "pretty modest incomes".
"In any other walk of life he would have been sacked - I can't argue against that"
He said most relatives working for MPs were "generally people of very high calibre" who worked very long hours and "actually the taxpayer gets thumping good value from them".
Asked whether Mr Conway should step down straight away, the Conservative former chancellor Ken Clarke told BBC One's Question Time: "Personally I'm inclined to leave that to Derek.
"In any other walk of life he would have been sacked - I can't argue against that....but I say that with a very heavy heart. I'm astonished by all this - I like Derek Conway he has been a very good MP - so I don't like having to say that, it's up to him."
Prime Minister Gordon Brown said earlier there should be greater transparency over MPs' expenses - but said the Commons authorities should decide how to achieve it.
Mr Conway said on Wednesday he would step down to prevent further damage to his party and has apologised for "administrative shortcomings and the misjudgements".
He also faces a possible police inquiry and a further probe into complaints about his other son, Henry.
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