The allegation was made by a member of the Stolen Generations Alliance of Aborigines, who were forcibly removed from their homes to be raised in white institutions in an attempt to foster assimilation.
"As well as being taken away, they were used ... there are a lot of things that Australia does not know about," Kathleen Mills told the first day of the inquiry into compensation for the so-called "Stolen Generations".
Treatment for leprosy
Outside the hearing in the northern city of Darwin, Mills told reporters her uncle had been a medical orderly and had told her that children were used as "guinea pigs" for leprosy treatments.
"He said it made our people very, very ill ... the treatment almost killed them," she said. "It was a common experience and a common practice."
The leader of the Greens party, Senator Bob Brown, said he was "shocked and alarmed" by the "very, very serious" allegations and called for them to be investigated.
"It may be right, it may not," he said. "It needs investigation.
"If within the indigenous community there is a feeling that children may have been experimented upon for a treatment for leprosy or anything else, the air needs to be cleared."
Prime Minister Kevin Rudd issued a formal apology to the Stolen Generations in an historic address to parliament in February.
Up to 50 000 mainly mixed-race children were taken from their families until 1970 in a bid to assimilate them into white society, while full-blooded Aborigines were expected to die out.
The inquiry is examining a compensation scheme for victims and their descendants that could involve payments of A$20 000 plus A$37 000 for each year of institutionalisation.