Premier Dominic Perrottet announced the decision to pursue the project on Wednesday as NSW faced a repeat of widespread flooding, with a month's worth of rain predicted to fall on saturated catchments in the coming days.
"Today is a landmark day ... for a project that has been talked about for decades," he told reporters.
The declaration of the dam wall raising as Critical State Significant Infrastructure exempts the development from some aspects of environmental and planning laws.
Mr Perrottet stressed he didn't want the vital infrastructure bogged down in red tape and government bureaucracy, saying "we need to prepare, we need to invest".
"It is all about saving lives and protecting property," he said, adding the project was necessary to help protect western Sydney from floods.
An independent flood inquiry report had determined the best way to protect western Sydney communities downstream from the dam was to raise the wall, Mr Perrottet said.
It was the most effective long-term flood mitigation strategy to help protect residents in the Hawkesbury-Nepean, which had been repeatedly hit by floods, he said.
In the case of another major flooding event in the Hawkesbury-Nepean area, raising the dam wall would reduce those properties affected from 15,000 to 5000.
The number of people needing to be evacuated would be reduced from around 90,000 to 14,000, the premier said.
Water Minister Kevin Anderson said the cost of damages would also be reduced by up to $8 billion if the wall was raised.
Labor's alternative plan to lower Warragamba's water supply level by 12 metres would lead to severe water restrictions for Sydney residents and higher bills, he said.
But Labor's Penny Sharpe said the project risked the World Heritage listing of the Blue Mountains National Park and it remained unfunded despite 12 years of coalition government.
She said it wouldn't be finished for at least eight years and it would fail to prevent flooding in the Hawkesbury-Nepean region as nearly half of floodwaters in the area came from catchment areas that weren't upstream from the dam.
Labor has committed $225 million for a western Sydney flood resilience plan for projects including evacuation roads, levees and critical communications infrastructure to bolster flood prevention and evacuation infrastructure.
WaterNSW will respond to issues raised in submissions on the project before a comprehensive assessment was performed in line with planning laws.
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