Proposals to change the link between Labour and the unions have been approved at a conference of party members by an overwhelming majority.
Leader Ed Miliband had urged a "one member, one vote" system for leadership elections and an end to the automatic affiliation of union members.
He praised the party's "courage to change" after members backed the plans by 86.29% in favour.
Unite boss Len McCluskey said union members would "rise to the challenge".
Conservative Party chairman Grant Shapps dismissed Labour's reforms, insisting the balance of power remained with the unions.
Addressing the conference after the vote, Mr Miliband insisted members should be "proud of the Labour Party".
He said he had taken a "big risk" in proposing reforms last July, stressing: "I did not believe we could face up to the challenges the country faced if we didn't face up to the challenges faced by our party."
Some British people felt Labour had recently lost touch, he said, adding: "You were right."
He later tweeted: "The reason we have changed our party today is so that we never lose touch again. #OneNationPolitics"
Mr McCluskey said the reforms would help to start "involving more trade unionists in the business of the party".
But he also fired a broadside at Mr Miliband, who had asked police to investigate the alleged rigging of a Labour candidate selection by Unite in Falkirk, which prompted the proposals debated on Saturday.
He repeated his assertion that "my union has done nothing wrong", declaring to loud cheers: "This is our party and we are going nowhere."
The BBC's chief political correspondent Norman Smith said it was interesting that opposition to the reforms had come from ordinary party members rather than trade unionists - perhaps underlining concern about how the changes would affect their own votes.
And BBC political correspondent Iain Watson said critics had pointed out that the reforms were not as radical as Labour suggested.
Under the changes, unions would still control 50% of votes at Labour conferences; there would be no cap on union donations; and some of the changes would be phased in over five years, our correspondent reported.
Earlier, Mr Miliband received a standing ovation from union members, constituency MPs and members of local parties from around the country at London's ExCel centre, as he urged them to "seize" the chance to change Labour.
He said the changes would attract thousands of new supporters.
Breathe new life
Historically, millions of union members have been automatically affiliated with Labour, but few take part in campaigning activities or even vote in general elections.
By being allowed to actively opt in to be a supporter, for a £3 fee, Mr Miliband has argued Labour would be transformed into a genuine "mass movement" again, in contrast to the Conservatives.
Labour leadership elections have previously been decided by a complex electoral college system, with equal weight given to the votes of three groups - one third to MPs and MEPs, one third to ordinary party members and one third to trade unionists.
Mr Miliband won the last leadership election largely thanks to support from unions, but Mr McCluskey said he suspected only 10% of its one million members affiliated to Labour would opt to stay in if asked now.
But Mr Miliband said a "one-member, one-vote" system would breathe new life into the party, completing a process started by former leader John Smith more than 30 years ago.
Meanwhile, the Trade Unionist and Socialist Coalition, which is not affiliated with Labour, demonstrated against the changes outside the centre.
Mr Miliband's proposals have already led to the GMB union reducing its affiliation funding. Unite will discuss its funding arrangements next week.
Some delegates warned Labour's against diluting its union links.
One local party member, a retired postal worker, said the changes were being foisted on the party to appease right wing media and the Conservatives.
Labour ministers, the party's ruling National Executive Committee and the big trade unions had already expressed support for reform.
And former prime minister Tony Blair said Mr Miliband had shown "real courage" on the issue, which was "long overdue".
But Conservative Party chairman Grant Shapps dismissed the changes as "a big victory for the unions".
"Ed Miliband is left with a situation where the unions are now his political life support machine," he said.
"That means all Ed Miliband offers is more spending, more borrowing and more taxes. It's the same old Labour Party."
Labour grandee John Prescott welcomed the "big change".
"The movement's got together, it's took a risk... That's what you expect from leaders, they look ahead and they've got the courage to make a decision."
Unison general secretary Dave Prentis urged members to turn their attention to the next election.
"Our money will remain, they will get our affiliation fees and we will move forward to win this election for Labour," he said.
"The coalition are the real enemies, not the trade unions."