Plans to reform Labour's union links risk ruining the party financially unless Ed Miliband backs bolder policies over the next year that encourage individual trade unionists to join, the boss of Britain's biggest union has warned.

Len McCluskey, Unite's general secretary, said he broadly supported reforms proposed by Miliband in response to the Falkirk selection row, arguing that the current relationship in which union members who paid the political levy automatically provided the party with funds was "not working".

In a frank interview with the Guardian McCluskey said Miliband's plan for union political levy payers to be asked to join Labour individually rather than being automatically signed up en masse was "a really good, morally defensible idea".

However, McCluskey cautioned: "Whether it works in practice we will have to wait and see. The gamble and the danger is whether it will bankrupt the Labour party."

Since Miliband was elected as leader, Unite has provided £8.4m in funding to the party.

McCluskey added that he would be delighted if Miliband achieved his goal of persuading 10% of the 3 million political levy payers to join the party.

But in a stark warning, the Unite boss said that there was clearly a danger that Miliband's plan "could fall flat on its face and fail". He added: "There is no doubt we would have to work very hard because our members are not queuing to join the Labour party, or be associated with the Labour party. That is really Ed's challenge."

McCluskey said the likelihood of individual union members joining the party would depend on shifts in Labour policy, which he described as no longer a logistical or administrative issue but an ideological one.

Miliband "has got to give ordinary trade unionists reasons to want to be associated with the Labour party", said McCluskey.

"And that really is about policy," he added. "He [Miliband] knows within this next 12 months he has got to start out with policy that gives hope to people and something different from the austerity programme that the government is pursuing that engenders nothing but fear." Policies highlighted by McCluskey (pictured) as likely to be popular with his members included repealing the bedroom tax on excess rooms in council homes, opposing the welfare cap, breaking with "austerity spending", building 1m extra homes and increasing the statutory £6.19 an hour minimum wage by £1.50 an hour.

He said: "Miliband has got a real task on his hands. The prize of being prime minister is within his grasp … but he has to be bold – and not just on issues that ordinary working people don't give a toss about like the union block vote."

The union boss was also frank about the failings in the current institutional links between the party and the unions. "One thing is clear: the current relationship that we have between the union and the Labour party is not working. Recent events have made me reflect on what we do. I can no longer defend putting 1 million of my members as affiliates to the Labour party when our own internal polling demonstrates that a large chunk of that 1 million vote for other parties.

"I have got to be honest with you. I cannot justify that. We badly needed to change the relationship anyway."

McCluskey concedes that accepting the shift to individual affiliation will have a wider knock-on effect, including on union voting power at conference. Acknowledging that "the whole dynamics change dramatically", McCluskey said he was "up for doing something different".

He said he would prefer to have one-third of the vote at a conference that meant something, where the leadership took notice of what was being passed, rather than 50% where it is ignored. "I don't understand the people who want to maintain the status quo. At Labour party conferences over 220 constituencies – a third – don't even bother to send anyone. If that does not tell you something is wrong in our party, I don't know what does."

Equally, he says he is willing to try primaries for Labour's London mayoral candidates.

Currently, Labour's candidate for London mayor is chosen from an electoral college of 50% trade unionists and 50% party members.

The Unite general secretary concedes that if few union members affiliate individually, the coffers of the union's political fund will correspondingly swell since the fund is not being used to pay large-scale affiliation fees to the party.

Some of that money, McCluskey argued, could be used as donations to Labour with the union bailing out the party if it got into trouble. He said: "Unite is not looking to bankrupt the party and we will continue to support the Labour party in any way we can without either becoming a problem."

But asked if the union would in future channel funds to the party through one-off donations, instead of annual affiliation fees, McCluskey stressed the potential bargaining power the switch from automatic affiliation gives his union.

"Yes, we want Labour as a party back in power, but of course it depends on the policies Labour themselves are adopting, and in the context of whether we would give donations that would be determined by my executive and my political committees. It is a collective decision."

McCluskey appears to accept his union's image has been damaged by the allegations of packing selection meetings.

He refused to accept his union acted improperly in the way it tried to recruit Unite members to Labour ahead of the Falkirk parliamentary selection – or, more widely, by seeking to organise union friendly candidates – but admitted that he regretted using a longstanding party-sanctioned scheme that allowed the union to pay the party subscription of new members.

The Falkirk row has led to two senior Unite members being suspended from the party, a police investigation and the taking over of the local party by the national party. It also led Miliband to condemn the worst form of machine politics and call for the wider review of the union link.

"If I could turn the clock back I would stop the idea that Unite pay an individual's membership fee to join an organisation. It is something I actually disagree with when I really examine it. I have to say that had the Labour party not stopped the scheme we were about to announce we would not use the scheme again because I recognise that the perception is in Falkirk that we have moved to buy votes in the constituency. I now recognise that is the perception. It is false, but perceptions matter," McCluskey said.

However, he is adamant that the central charge of Unite signing up members to the party without their knowledge is false. "If there was evidence of that I would condemn that and take action. I am advised that did not happen and for us to be crucified in the way that we have is absolutely wrong, including by Miliband and the Labour leadership."

He described the Labour inquiry as a sham and is furious about the police being called in by the party. He said: "I have seen this a thousand times in my life: you mention the police because it creates fear and the outside perception is there must be something in this. It is the oldest tactic in the book and it is shameful."