Scotland is the most centralised nation in Europe with a few elected representatives covering large populations and geographical regions, the Convention of Scottish Local Authorities (Cosla) said.
Local democracy "has been gradually dismantled over the last 50 years" from over 400 elected local governments in 1946 to 32 today, according to an interim report by Cosla's commission on strengthening local democracy.
Communities have "very limited local tax capacity and a high dependency on grants from national government", and only "a radical and fundamental overhaul" of local democracy in Scotland will resolve the issue, it said.
Commission chairman David O'Neill said: "Whatever the result of the (Scottish independence) referendum, we've got a huge opportunity to think about the kind of country that we want to live in, and make sure that there is a lasting local legacy for local communities in Scotland.
"This won't be achieved without a radical new way of thinking.
"Strong local democracy needs much more than a trickle down of powers from national government, to councils and only then to communities.
"Instead, we need to rethink local democracy from the bottom up."
Scotland would be fairer, wealthier and healthier if local communities had control over the issues that matter to them, the commission said.
The report said: "Larger and more geographically distant bodies could find it easier to cut local services.
"However, the opposite is a much positive and powerful proposition - real improvement to outcomes and long term effectiveness will only be achieved by empowering local people to take meaningful decisions about what works locally."
The average Scottish local authority represents the interests of around 165,000 people across 2,500 square kilometres, compared with around 5,000 people across 50 square kilometres in the EU.
The report said: "If several hundred local governments made cultural sense in the 1960s, why was 32 culturally acceptable by 1996?
"One answer might be that no-one in Scotland was ever asked. The sequential rationalisation of Scottish local government proceeded without referenda or any systematic attempt to establish public preferences.
"A long-term centralist trend in Scotland and the UK has reduced the number of local democratic institutions, increased their scale and reduced their powers and functions.
"The scale of rationalisation/reduction is significantly greater than elsewhere internationally."
It added: "The Commission is not focused on a particular government or ministers, but on confronting a 50-year trend in the structures of governance in Scotland that suggests centralisation as the default position.
"Up to the 1960s, Scotland was closer to the international norm: a large number of relatively small local governments that on average raised over 50% of their income locally, different functionalities and empowerment in different parts of the system, and distinct arrangements for cities."
The report continued: "Greater fiscal decentralisation is required so that local communities are empowered to participate in and inform choices about the public services they want and how these will be funded.
"Reinvigorating local democracy means having the same freedom to reflect local choices about tax and spend in Scotland that already exist in most modern democracies."
Scottish local government minister Derek Mackay said: "The Scottish Government supports subsidiarity and local decision making and believe that the people who live and work in Scotland are best placed to make decisions about the country's future.
"We are already taking steps to give communities greater opportunities to influence and take control of their own future through the Community Empowerment bill, and our ground-breaking discussions of the Island Areas Ministerial Working Group and our work as part of the Scottish Cities Alliance recognise the different needs of all parts of Scotland.
"With the full powers of independence we will have the best prospect of properly empowering Scottish communities in the full range of decisions that affect them."
A UK Government spokesman said: "The UK Government's firm belief is that local areas across the country should be empowered to influence and be fully involved in decisions that affect them, to have the power to decide how public money should be spent and to do what they think is best to help businesses grow and create economic growth.
"We are committed to an open dialogue with Cosla, individual local authorities and groups of local authorities across Scotland where they are making such a case for change. Not just on if there should be change but what that change should be. Our on-going work with the Our Islands Our Future campaign and with the City Deals programme demonstrates our willingness to consider ideas.
"Equally, flexibility must not only relate over the transfer of power from London to Edinburgh and there is nothing to stop the Scottish Government handing over more powers to local communities across Scotland right now."
Scottish Labour's local government spokeswoman Sarah Boyack said: "Since the SNP became the Scottish Government, local authorities have been systematically stripped of power and left with the challenge of providing more services with a flat cash settlement in order for the SNP to keep their promise of a council tax freeze.
"Our view, as outlined in Powers for a Purpose, is to devolve powers back to councils so that decisions can be made at a local level and meet the specific needs of the areas being served. We advocate transferring both powers and resources to enable local authorities to create jobs, regenerate our communities and start to tackle our housing crisis.
"Our plans would mean not just devolving powers to local government to reverse the SNP's centralising agenda, but crucially to address the fact that the Scottish government totally controls local government finance."
Green MSP Alison Johnstone said: "This report strengthens the case for a new deal for local democracy in Scotland. The Commission has clearly identified that people just don't feel very engaged with local decision-making and now the challenge is for them to identify bold solutions.
"As Scotland debates whether powers should shift from London to Edinburgh we must come up with new ideas for passing more control to local communities."