Gordon Brown should immediately reform the system for appointing peers in response to the cash-for-honours affair, a cross-party committee of MPs has said.

In an explosive report to be published tomorrow the committee says that there should also be a new Corruption Act and new powers for party funding watchdogs to help prevent a repeat of the affair, which led to the arrest of two of Tony Blair’s closest aides.

It also says that Scotland Yard always had a low chance of securing a prosecution under the 1925 Honours (Prevention of Abuses) Act during its 18-month investigation.

It says that donors and political parties would need to be “caught red-handed” making an agreement that the donor would get a peerage. The committee says that it had no comment to make on the conduct of the lead detective, John Yates, the Metropolitan Police assistant commissioner.

The report from the Commons public administration committee, chaired by Tony Wright, a Labour MP, urges immediate and fundamental reforms to the system for appointing peers. The committee also accuses political parties of breaking the spirit of the donations law. “A deliberate attempt was made to stretch the loophole on commercial loans as far as it would go,” the report says.

Among the 44 recommendations in the report, according to The Guardian newspaper, are that:

— The marketable value of a peerage as a political honour should be reduced by saying it will not allow the person to sit in the House of Lords;

— The Prime Minister, Gordon Brown, and his successors should renounce their right to create peerages and to appoint the people who vet the nominations;

— All peers should pay British taxes;

— The names of all people recommended for peerages should be published;

— There should be the creation of a new corruption law — keeping the 82-year-old Honours (Prevention of Abuses) Act but adding new provisions allowing MPs and peers to be prosecuted for bribery;

— The powers of the Electoral Commission should be enhanced to act against political parties breaking laws on donations.

The MPs will urge Mr Brown to take action immediately, saying that he could make many of the changes without needing parliamentary approval and effectively withdraw himself from the process.

It was reported last night that the committee’s MPs will say: “The point is that it could be done now if the Government wanted to. We believe it should, as an immediate and proper response to the lessons to be learned from recent events.”

The committee began its investigation in March 2006 after it was disclosed that Labour had received undeclared loans before the last election from four donors nominated for peerages by the former Prime Minister, Mr Blair. The four were Barry Townsley, a stockbroker; Dr Chai Patel, chief executive of the Priory Clinics; Sir David Garrard, a property developer; and Sir Gulam Noon, head of Noon Foods.

Mr Yates asked the committee to put its inquiry on hold until his own investigation had concluded.

It was only in July of this year — after the arrests of Des Smith, a member of the Specialist Schools and Academies Trust, Lord Levy, Labour’s chief fundraiser, Ruth Turner, Mr Blair’s “gatekeeper” and Sir Christopher Evans, a businessman who had lent Labour £1m in the preceding months — that the inquiry concluded.

On July 20, the Crown Prosecution Service decided that no charges should be brought.

Despite this, however, the £1 million 18-month investigation cast a long shadow over the final days of Mr Blair’s government and is widely believed to have hastened his departure.

The committee report also contains a warning for the Conservative Party with its conclusion that all peers should pay British taxes, ending the current “ad hoc” rules that have allowed the Tory peer Lord Laidlaw of Rothiemay, who lives in Monaco, to fail to honour his pledge that he would cease to be a tax exile once he got a peerage.

The findings say that although it is nearly impossible to prosecute someone under the 1925 Act, unless they are “caught red-handed”, strengthening this law would be only a partial answer.

It concludes that it is necessary that the rules for entry to the Lords should be “clear, widely agreed and of unquestionable legitimacy”.

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