Auditors have found "weaknesses" in the contract between the government and Atos, the private firm paid to carry out fit-to-work medical assessments.
The contract underpins the Department for Work and Pensions's efforts to move people from sick benefits into work.
The National Audit Office said the DWP had failed to penalise Atos for "underperformance", and had not set "sufficiently challenging" targets.
Ministers said the terms of the contract were under "constant review".
French firm Atos was paid more than £112m in the last financial year to carry out about 738,000 face-to-face medical tests on benefit claimants.
The DWP used the test results, known as work capability assessments, to decide whether people were fit to work or eligible for Employment and Support Allowance (ESA).
The assessments were first introduced on a pilot basis by Labour in 2008 and rolled out across the country by the coalition government.
Officials at the DWP have got many decisions wrong, with nearly four out of 10 appeals upheld at tribunals. The NAO said it was unclear whether the quality of the tests was to blame for the number of wrong decisions.
In a letter to Tom Greatrex, MP for Rutherglen and Hamilton West, the NAO's Comptroller, Amyas Morse, said it was hard to know whether changes to the tests were needed.
"It is difficult to assess, as the department does not routinely request feedback on the rationale for tribunal decisions," he said.
"Without such data it is not clear whether any changes in the medical process are needed."
The DWP had previously admitted that Atos had not carried out some fitness testing within the agreed time limits, and performance had been "below the standard" since mid-2011.
The NAO criticised the DWP for not seeking "financial redress" for these delays, saying just 10% of the penalties triggered by poor performance had been applied.
The spending watchdog added that the DWP's negotiating position has been undermined by "inaccurate forecasting" of the number of people likely to need a medical test.
Mr Greatrex said he had asked the NAO to review the contract after being told by ministers that the details, including information about financial penalties, were "commercially confidential".
"My underlying concern was the fact that the contract is worth £112m a year to Atos," he told Radio 4's Today programme.
"At the same time, through the Tribunals Service, the appeals are costing about £60m a year so effectively we are paying twice to try to correct the mistakes in the initial assessments or the process that leads to the assessments and decisions.
"That isn't good value for money and this is a contract that really needs a lot more scrutiny to understand how effective it has been."
Mr Greatrex urged ministers to reflect on the report and consider reforming the system.
Major changes to the tests were recommended in 2010 by independent adviser Professor Malcolm Harrington. Last month he told the BBC the system had improved but was still "patchy".
The DWP said the contract had "changed considerably" since it was signed by the Labour government in 2008 and ministers had twice - in 2009 and 2012 - demanded improvements.
Feedback from tribunals was now fully evaluated, it added, and in many cases new information was presented at appeal which was not available when the assessment was conducted.
"In 2010, the Work Capability Assessment was not working properly and since then we've substantially improved it," said Work and Pensions Secretary Iain Duncan Smith.
"It is a complicated area but we are committed to making it a success to ensure it is both fair and accurate for the user and value for money for the taxpayer."
A spokesperson for Atos said it had worked very closely with the DWP on a "complex and challenging contract" to "fulfil all our contractual obligations".
"We have also been flexible within the contract, for example implementing changes and recommendations from the Harrington report.
"Where changes to the contract have resulted in slower processing times we have worked alongside the department to address this."
Regular complaints have been made about the medical tests since they were first introduced.
In May 2011, six charities - including the MS Society and Parkinson's UK - urged the government to make the tests fairer for patients whose symptoms varied in severity over time.
A month later, campaigners claimed in a letter to the Guardian newspaper that assessments were causing "huge" distress and had even resulted in suicides.