MPs are currently discussing closer checks on how local authorities are spending the money they get to invest in roads, light rail and buses amid fears cash-strapped councils are diverting funds to other projects.
Restrictions should also be put in place to make local authorities spend the cash they earn from car parking charges on transport schemes in the area, the Public Accounts Committee recommended.
The Department for Transport hands over £2.2 billion to fund local schemes but £1.2bn of that is not ring-fenced and could be spent on any capital project, the PAC found.
Margaret Hodge, who chairs the committee, said: "The Department for Transport makes a substantial contribution towards the funding of local transport services, but has no clear way of controlling how this money is used.
"Local authorities are facing significant budget cuts but the department does not have the information to assess the impact on transport services, or to make comparisons between local areas to identify councils that are underperforming.
"It is also unclear how the department would identify a failure or unacceptable deterioration in services, or when and how it would intervene."
RAC Foundation director Professor Stephen Glaister said: "This report is damning. The Department for Transport is dishing out billions of pounds to local authorities with no idea of what it is being spent on. In fact there is no guarantee the money is funding transport schemes at all.
"Instead of going towards repairing potholes, it might simply be being used to fill the financial black holes appearing in other areas of councils' budgets."
He went on: "And things have the potential to get worse rather than better. More major transport decisions are being devolved to new non-statutory bodies, but the report points out that the department is relying on little more than the 'common sense' of those involved to make sure they work."