The Schizophrenia Commission, set up by a charity a year ago, said patients spent too long in “demoralised and dysfunctional” hospital wards.
It says the condition costs society almost £12bn a year and money would be better spent on preventing illness.
The government says mental health is one of its high priorities.
A spokesman said: “We are clear that people with mental health problems should be treated with the same high quality and dignified care as anyone else and we expect the NHS to make this happen.”
The commission, which was established by Rethink Mental Illness, says too much is spent on secure care – 19% of the mental health budget in England last year – with many people staying too long in expensive units.
Among the 42 recommendations, the report calls for a better use of “recovery houses” in the community, to provide an alternative to hospital admission.
The average cost of a night in a mental health in-patient bed is £321 – meaning a typical admission of 38 days costs more than £12,000.
Schizophrenia is a disorder which affects thinking, feeling and behaviour and symptoms can include delusions, hallucinations such as hearing voices, and loss of interest, energy and emotions.
The commission says early intervention teams, which aim to help people before their hallucinations or delusions become severe, are popular and should be extended. The report claims some teams are being cut or diluted at the moment.
Commission chairman Prof Sir Robin Murray, from King’s College London, said: “If you have psychosis and your mind is disturbed, you need a period of respite and calm.
“But especially in inner cities, you get admitted to something like a madhouse. The nurses are often overwhelmed.”
He said that improving in-patient units had to be a top priority, “to give people a better experience so that if they have another episode then they’re quite willing to have treatment”.
“One other thing we can do is to stop spending or wasting so much money on high-security for so long. I think we could save a lot money by getting people rehabilitated quicker, and out of these secure units.”
While there is often perceived to be a link between schizophrenia and violence, this is exceptional and many people with the condition live stable lives.
Sir Robin said: “There’s a preoccupation with risk, and the idea that this is a madman with an axe. But people with schizophrenia are actually more likely to be attacked themselves.
Dan Lowe, 36, began having psychotic symptoms 16 years ago.
He has been admitted to hospital four times, each stay lasting several months.
Dan says he found the stays in hospital sometimes made his paranoia worse, but is now taking clozapine, which has helped his recovery.
Dan lives independently in Surrey, with support from a community psychiatric nurse and enjoys taking part in a regular computer course.
“There’s no other condition where such an emphasis is put on the risk of an effect on other people.”
An economic analysis for the commission highlighted an “exceptionally low” employment rate for people with schizophrenia of 7%, as well as disrupted education – because the illness often develops in young adulthood.
The authors said some of the costs of schizophrenia were unavoidable, but effective interventions, such as family therapy and making a concerted effort to find people jobs, were not being widely used.
Paul Jenkins, head of Rethink Mental Illness, was also a member of the commission.
He said: “It’s been over 100 years since the term ‘schizophrenia’ was first coined, but care and treatment are still nowhere near good enough.
“It is a scandal that in 2012 people with schizophrenia are dying 15-20 years earlier than the general population.”
The report said tackling those physical health consequences would take many years, but made economic sense.
And it highlighted poor prescribing practice as another problem faced by people with schizophrenia, saying patients were not always receiving the most effective medication.
The report – titled The Abandoned Illness – concludes patients can be given hope and support, with the aim of stability or recovery.
By Jane Dreaper, BBC News