The current methodology, introduced by the Howard Government, bases funding on the average socio-economic scores (SES) for the census district a school is located in.
However, the National School Resourcing Board says parental income would be a more reliable measure to determine funding.
"Capacity to contribute" would be based on the median income of parents at the school.
"The report makes it clear this direct measure of parental income can now be used without breaching privacy or requiring the collection of tax file numbers by a school," federal Education Minister Simon Birmingham said in a statement.
"The report’s recommendations offer the potential to achieve a clearer picture of the capacity of families at non-government schools to contribute to the costs of their children’s education."
The Turnbull Government set up the independent National School Resourcing Board in response to recommendations from businessman David Gonski.
The board recommended the current system stay in place for 2019, and no change be made until at least 2020 to provide funding certainty for schools.
Birmingham said the Government would now investigate how to refine the SES methodology and transition to a new system.
National Catholic Education Commission director Ray Collins said the current method was fundamentally flawed, but the new model also raised some questions.
“Of particular concern is the impact of a new methodology on long-established, low-fee charging Catholic schools in metropolitan areas,” he said.
“We believe there is a lot of hard work ahead before a realistic funding model can be achieved.”
The Independent Schools Council of Australia said further work was needed on the new model, especially as it applied at an individual school level.
"As part of moving away from the current indirect measure of 'capacity to contribute', the independent sector must be assured that any direct measure will be significantly more accurate and will be consistently applied to all non-government schools,” ISCA director Colette Colman said.