Yet crime rates were now the lowest they had been since the late 1970s.
The report's authors, led by a clinical psychologist and science adviser to the justice sector, Associate Professor Ian Lambie, argued the trend was driven by successive policies implemented so as to be seen to be tough on crime.
This had reflected a "progressively retributive" rather than a restorative approach to crime, they said.
"We keep imprisoning more people in response to dogma not data, responding to shifting policies and media panics, instead of evidence-based approaches to prevention, intervention, imprisonment and rehabilitation," the authors said.
"This does not diminish the importance of incarceration for a subset of individuals so as to protect the public."
Evidence suggested prisons were "extremely expensive training grounds" for further offending and worsened inmates' prospects on the outside.
Former inmates also faced higher rates of undiagnosed addictions and mental illness, and there was a knock-on effect to the next generation. Maori were particularly affected.
Other countries, such as Finland, had significantly reduced incarceration rates without crime rising, and there was strong evidence for interventions and a "smarter approach" to rehabilitating those already in the system.
"With leadership and knowledge, we can fundamentally transform the justice system, reduce victimisation and recidivism and make prisons only a part of a much more proactive and effective systemic response to a complex problem."
Justice Minister Andrew Little said the report highlighted the need to tackle the underlying causes such as poverty, housing, poor education, mental health and addiction.
"We've got to deal with the immediate pressure, which is the current prison population and a prison system that is now stretched to breaking point," Little said.
"And we've got the long-term issues, which is about making sure that right throughout the criminal justice system the interventions are the right things, and what we're doing with people who are in the criminal justice system is reducing the chance of reoffending and keeping the community safe."
The Government aimed to reduce prison populations by 30 per cent over 15 years - something Little said couldn't be done without addressing criminal justice measures.
READ MORE: Andrew Little: 'Longer sentences, more prisoners - it doesn't work and it has to stop'
"It takes a sophisticated approach and I expect we will make some decisions in the next few weeks that we will start to roll out."
National's justice spokesman, Mark Mitchell, said it was "worrying" the Government had a firm target to reduce the prison population but not to reduce crime rates.
He said the cost of prisons shouldn't be an excuse not to put people in prison, "if that's where they need to be".
READ MORE: Political Roundup: Is the prison system broken?
"The priority must be to ensure that victims are kept safe from violent criminals."
Mitchell said although the overall crime rate had dropped, much of that was because of a fall in lower-level offending, and violent crime - which offenders were largely jailed for - had actually increased 4 per cent since 2011.
Justice advocate Kim Workman hailed the report, saying he had "not read anything as compelling in nearly 60 years' involvement in the criminal justice system".
"It expands our understanding of who victims are, moving from the binary 'good victims, bad offenders' stereotype which has shaped our thinking over the last 30 years, towards a true understanding of who victims are, and how they became victims," Workman said.
"It cites all the evidence available to support the development of a progressive criminal justice system, not just that evidence that supports a retributive mindset."
Howard League spokesman Roger Brooking, who is driving an email petition urging the Government not to spend $1b on another prison, said the report was an "excellent analysis" but felt it still understated the problem and fell short of making any hard recommendations.
Brooking argued repealing the Bail Amendment Act could reduce the prison population by about 1500 within 12 months, and the same number could be slashed by making more prisoners automatically eligible for release after serving half their sentence, instead of going before the Parole Board.
Canterbury University criminologist Professor Greg Newbold said reducing crime rates - and the prison population - was easier said than done.
"We could reduce the prison population by rehabilitating people - but achieving that is a different thing," he said.
"We can't do it, we've never been able to reduce the recidivist rate in over 100 years of trying."
Sensible Sentencing Trust spokesman Garth McVicar considered the report's overall argument simplistic, adding that the average inmate had 46 prior convictions.
"Trying to reduce the prison population without actually taking a big stick to the crime rate is ridiculous, in my opinion."
• The full report is available here.
