The All Party Parliamentary Group on Dementia says this would free ?1bn that would be better spent on improving community-based services.
Its report says failure to act will result in an "unqualified crisis".
However, some experts have warned that the savings would be difficult to achieve.
The APPG report says the annual cost of dementia is the UK has reached ?20bn.
Health and social care budgets are coming under extreme pressure, it warns.
But it says there is "ample opportunity" to spend the money more effectively.
It criticises the NHS for failing to place a priority on dementia services, and calls for better co-ordination across the system, including carers, GPs, care homes, hospitals and social care.
Crisis point
The report argues that people with dementia often go without support until they reach crisis point.
It says the care they then require is hugely expensive - much of it "unnecessary and completely avoidable".
In particular, it calls for changes to reduce inappropriate hospital admissions of people with dementia and to shorten their stay.
Drawing on data from the Alzheimer's Society and the Department of Health, the APPG says up to a quarter of hospital beds in England are estimated to be occupied by people with dementia aged over 65 years at any one time.
It says this means more than 26,000 people with dementia are in hospital at any one time, at an annual cost of more than ?2bn.
The APPG argues this could be reduced by moving treatment and care out of hospitals into community based services, and suggests that reducing acute and geriatric beds by at least 10% would release ?1bn.
The group says the money would be better spent on specialist support for GP practices to help diagnose dementia.
It also recommends strengthening community support to avoid emergency admissions, and providing day and night respite care.
Money 'thrown away'
The chair of the APPG on Dementia, Baroness Sally Greengross, said the plan could deliver immediate savings.
"Money is consistently being thrown away on poor quality services and inappropriate care for people with dementia.
"The Dilnot Commission last week put caring for older people firmly in the spotlight, but its recommendations are not yet a reality.
"Our report shows there are many ways to save money and improve care now."
Continue reading the main storyIf we take action now, we can reduce hospital admissions, reduce length of stay and improve quality of life for people with dementia”End Quote Jeremy Hughes Chief Executive, Alzheimer's Society Jeremy Hughes, chief executive of the Alzheimer's Society, said: "We can't keep using the chicken and egg excuse that it's not possible to cut hospital beds, and release funds, until community services are in place.
"The reality is, money is not being spent in the best way and NHS bosses must find a way to change this."
But Professor John Appleby, chief economist at health research group the King's Fund, warned that this was easier said than done.
"It can be difficult to free up resources in one part of the system to be spent in another.
"In theory, treating people in community settings should reduce bed use in hospitals, with the savings being used on community services. In practice it can be very difficult to realise such savings."
The chief executive of the NHS Confederation, Mike Farrar, said the report raised a difficult issue for politicians.
"Shaping dementia services to suit the needs of local people will require some frank and honest discussions about the need to close some services and move others out of hospital if we are to provide the best care possible in the future."
Care services minister for England, Paul Burstow, said dementia was a priority for the government.
"Early diagnosis is key as it allows people to plan for their future, preventing the need for crisis intervention and premature admission to acute hospital care.
"This delivers better outcomes for people with dementia as well as significant cost-savings"
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