Executives in the public sector should have 10% of their pay held back and would receive it only through good performance at the end of the year, under "radical" proposals by a Government-commissioned report today.
A so-called Fair Pay Review also called for greater public scrutiny of executive pay in the public sector and recommended that a workers' representative should sit on remuneration committees.
But the review, led by Will Hutton, ruled out having a fixed limit of senior staff earning no more than 20 times the lowest paid workers' earnings because it would be unworkable and affect only a small number of employees.
The report suggested instead that public bodies should publish a report every year on how much chief executives earned in relation to the median pay of a workforce.
Mr Hutton said all public sector executives should place an element of their pay, at least 10%, "at risk", to be earned back each year if they achieved pre-arranged objectives.
The scheme would be the first of its type in the world, affecting around 2,000 senior staff, but could spread to tens of thousands of middle managers on a voluntary basis.
Senior staff would not be eligible for a bonus unless they received the part of their pay which had been held back, the report suggested.
The "earn back" pay system could be in place within four years and would take some of the heat out of the debate about executive pay, said Mr Hutton, who is head of the Work Foundation.
Around 9,000 executives among the near six million public sector employees earned more than the Prime Minister's salary of £142,500 and their pay had been rising faster than low-earners, although not as much as in private firms, said the report.
Executives in private firms are consistently paid more than their public sector counterparts. The permanent secretary at the Home Office earns up to £197,000, managing a turnover of £10 billion, while an equivalent position in the private sector would pay £2.5 million, it was found.
Studies had found that council chief executives were paid just 51% of the salary of comparable jobs in private companies.
But Mr Hutton said public sector managers had been caught up in the backlash to the "remarkable" growth in earnings for executives over the past decade.
"The public has the right to know that pay is deserved, fair, under control and designed to drive improving public sector performance, and that there are no rewards for failure," said Mr Hutton.
Other recommendations included annual fair pay reports on trends in pay multiples across public services and a fair pay code.
Chancellor George Osborne said: "The Government is committed to striking a balance between value for money for taxpayers and fair pay for public sector workers. We will give careful consideration to his recommendations and respond in detail in due course."
Dave Prentis, general secretary of Unison, said: "The focus on top pay is a missed opportunity. To really boost fairness in the public sector, and our society as a whole, we need to tackle low wages - not just income inequality."
Mr Hutton argued that the public sector was not a very attractive place for "go-getters", adding that they preferred the performance regime of private firms.
He called for stronger governance over pay, adding that workers were some of the best people to judge what constituted good performance.
Jonathan Baume, general secretary of the FDA, which represents senior staff in the public sector, said: "Will Hutton's review offers the opportunity to repair the damage done to public trust and confidence about the pay for senior public sector managers and professionals, in the light of the MPs' expenses scandal and bankers' pay."
University and College Union general secretary, Sally Hunt, said: "One of the reasons vice-chancellors' pay has been so embarrassing for the sector has been the complete lack of transparency or reason behind the arbitrary, but usually handsome, rises."
Public and Commercial Services union leader Mark Serwotka said: "While the Government lays into high pay in the public sector, the scandal of executives in private companies creaming millions and millions of pounds of taxpayers' money is going on right under our noses."
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