The report by the conservative Menzies Research Centre also calls for an end to the use of the school curriculum to preserve Aboriginal culture, arguing this is a role for parents.
The report was prepared by the former Keating Labor government minister Gary Johns.
In the report, he argues that education offers the best chance of improving the well-being of indigenous Australians.
But Mr Johns says many outback communties are currently unviable.
Opposition parties have criticised the report which was released on Monday and accused Dr Johns of engaging in ideological warfare.
Greens Senator Kerry Nettle says more government funding, rather than cutting back services would alleviate Indigenous disadvantage.
The federal government has welcomed the report, describing its conclusions as sound.
The Federal Education Minister, Julie Bishop says often too much is expected of schools serving Indigenous communities.