Offenders who defy driving bans will be hit with up to 10 years in prison if they cause death and up to four years for serious injuries under the law reforms, which will be introduced next year.
Mr Grayling said the changes would send a clear message to drivers who flout bans and "go on to destroy innocent lives".
The current maximum sentence faced by a driver who causes death while driving when disqualified is two years in jail and there is no specific offence of causing serious injury while banned.
Mr Grayling also announced plans for a full review of all driving offences and penalties, which includes offences committed by uninsured and unlicensed drivers.
It comes after MPs pushed for a change in the law to deal with banned drivers following cases across the country.
The changes are expected to apply in Scotland because road traffic legislation is covered by powers reserved to Westminster.
Last year, husband and wife Ross and Clare Simons were on a tandem bicycle when they were hit by a Citroen Picasso in Hanham, near Bristol.
Drug addict Nicky Lovell, 38, who had 11 previous convictions for driving while disqualified, was being pursued by police at the time of the accident.
He pleaded guilty to two counts of causing death by dangerous driving and one of driving while disqualified and was jailed for 10 years and six months - the maximum sentence possible.
Mr Grayling said: "I want to make our roads safer and ensure people who cause harm face tough penalties.
"Disqualified drivers should not be on our roads for good reason. Those who chose to defy a ban imposed by a court and go on to destroy innocent lives must face serious consequences for the terrible impact of their actions.
"Today, we are sending a clear message that anyone who does will face much tougher punishment."
In 2012 there were 16 prosecutions and 13 convictions for causing death by driving when disqualified, unlicensed or uninsured.
Shadow Justice Secretary Sadiq Khan said: "Those driving without insurance that cause serious injuries or deaths should be properly punished.
"The Government also needs to assure the public that they have enough space in prison to cope with the increased demand. The current shortage of space and increased overcrowding on their watch has led to serious problems in our prisons."
Julie Townsend, deputy chief executive of road safety charity Brake, said: "We have long campaigned for a shake-up of charges and penalties for risky and irresponsible drivers who kill and injure on our roads.
"Brake supports families who have been deeply and permanently affected by selfish and risky behaviour at the wheel and we frequently hear from these families that they feel terribly let down by our justice system. As such, we strongly welcome Chis Grayling's announcement."
AA president Edmund King said; " A small proportion of drivers are serial offenders who need to be taken off the road.
"We support these changes as a deterrent to not re-offend or as a means of stopping those imprisoned who seem intent to be serial re-offenders."