Sending non-violent indigenous offenders with drug and alcohol issues to rehabilitation instead of prison would save $111,000 annually per person, a new report says.
The Deloitte Access Economics study found that diversion programs provided financial savings as well as improvements in health and mortality.
National Indigenous Drug and Alcohol Committee chair Ted Wilkes said prisons were failing to treat the underlying reason that often drives indigenous people to jail.
"Indigenous men were significantly more likely to report that they were intoxicated at the time of the offence," he said.
"Do governments really believe that prison is the best answer to these problems?"
Mr Wilkes said offending rates were high and incarceration was associated with poor health outcomes for prisoners, including a higher risk of death after release.
He called on governments to support justice reinvestment, a concept which involves shifting spending away from locking up offenders to community-based programs focused on prevention.
In 2011, $3 billion was spent on 115 Australian prisons.
However, only 30 facilities nationally provide drug and alcohol treatment to indigenous people.
A Senate inquiry is investigating justice reinvestment.