The report, commissioned by the Government, said the grand duchy, where 87 per cent of the 500,000 population is Catholic, allocates 95.6 per cent of the state budget for religious institutions to the Church.
These funds should be distributed more equally among religions and "non-religious philosophical communities," it said.
The same opening to other faiths and beliefs should apply to state schools, where 79 per cent of pupils receive a Catholic education, it said.
Justice Minister François Biltgen said the report was only the first step on the path to reforming church-state relations.
The grand duchy's parliament is due to debate the issue in December and January and formulate guidelines for the reform.