Labour's justice spokesman, Charles Chauvel, wants to eliminate jail sentences of less than six months because they are of "zero utility".
He said abolishing short sentences, commonly used for minor offences such as drug possession and stealing cars, would free up money to help offenders with their education and addictions.
Labour also proposes more use of police diversion for people caught possessing drugs or committing minor offences under the influence of drugs or alcohol.
This represents a major shift from the harsher sentencing policy for serious crimes implemented by Labour leader Phil Goff as Justice Minister from 1999 to 2005, and is the first time one of the two main parties has embraced the idea of treating drug use primarily as a health issue rather than a crime.
"To get cannabis use down it is better to treat it as a health issue, not a law and order issue," Mr Chauvel said.
But National's Police Minister, Judith Collins, rejected the health-first approach as "a soft on drugs attitude". She said: "We are not going to be soft on drugs and alcohol because they are definitely drivers of crime."
Labour's justice policy has not yet been released, but its health policy promises to "work towards greater opportunities for diversion from the criminal justice system into treatment for those found in possession of illicit drugs" and to "investigate the appropriate use of diversion for those committing a minor offence under the influence of alcohol or drugs".
It says Labour would "seek to implement the recommendations" of a recent Law Commission report which proposed giving cannabis users three warnings, requiring them to attend a "brief intervention" with a treatment service after the third warning.
They would be prosecuted only if they were caught with cannabis again after the third warning.
Mr Chauvel said Labour would also establish a Sentencing Council, something approved by the last Labour Government after a 2006 Law Commission report but dropped by incoming National ministers in 2008.
"That will, over time, eliminate the need for prison sentences of less than six months. There is a vast number of sentences that are of less than six months ... and I think that costs the Crown $45,000 per [six-month] sentence.
"If you get rid of those, and recommit that money to community-based sentencing and restorative justice, where they learn to make [restitution to] the victim of crime, you can eliminate enough prison beds to be able to pay for alcohol and drug treatment and literacy and numeracy in the prisons."
He expected that a Sentencing Council would wipe jail terms of less than six months.
"The Law Commission report on the Sentencing Council concluded that those short sentences were of virtually zero utility."
Victoria University criminology professor John Pratt agreed that such sentences "achieve nothing at all".
"All they do is take away someone's opportunity of making any good in life because they will lose their job, quite possibly lose their house if they are paying a mortgage, and possibly lose their family," he said.
Ms Collins said police already used diversion for minor drug possession but she opposed extending it to offences committed under the influence of drugs or alcohol.
* Eliminate drug / alcohol sentences under six months.
* Use money saved on education/rehab.
* $45,000 cost to Govt per six-month sentence.
* More use of diversions for minor offences involving drugs/alcohol.