The Home Affairs Select Committee said up to 65 per cent of private detectives are former police officers, and some had "close links" to serving members of forces.
Its inquiry heard that one firm had paid £20,000 to confidential sources including "possibly serving police officers", and had employed one officer.
The cross-party group urged the Government to "sever the links between private investigators and the police forces".
It recommended a one-year "cooling off period" between retirement from the force and working in private investigations, that all contact between police and PIs should be formally recorded and that the Independent Police Complaints Commission should look at all cases of alleged corruption.
The committee's report also called for an increase in the "derisory" fines averaging £100 for the unlawful trading of personal data, and the establishment of a robust registration system for investigators.
It said the phone-hacking scandal was just the "tip of the iceberg" of a black market in confidential information, and that the internet and new technology were making it easier than ever to trace people and carry out surveillance on them.
Keith Vaz, the Labour chairman of the committee, said: "Recent high-profile events, such as the phone hacking scandal, have thrown light on the sometimes shady world of private investigators. We have found that rogue private investigators are the brokers in a black market in information. They illegally snoop on our data, cash in on our private lives and only get away with a paltry fine.
"The public must be assured that those acting as 'private investigators' are subject to stringent checks, act under a code of conduct, and will face tough penalties if they step out of line.
"It is also time for the link between private investigators and our police forces to be broken. Officers must be compelled to declare any dealings with private investigators and be subject to a cooling off period before they can move from the police service to the private investigation industry.
"It is time this industry was regulated, so that the honest majority can get on with their work. We expect the Government to act urgently."
