The internet is a "fertile breeding ground for terrorism" and plays a part in most, if not all, cases of violent radicalisation, MPs said today.
Internet service providers should be more active in monitoring the sites they host and the government should work with them to develop a code of practice for the removal of material which promotes violent extremism, the report said.
It comes as four radical Islamists will be sentenced this week for plotting a major pre-Christmas terror attack on the London Stock Exchange after being inspired by the preaching of the recently killed extremist Anwar al-Awlaki.
The nine-month inquiry by the Commons Home Affairs Select Committee found that the internet played a greater role in violent radicalisation than prisons, universities or places of worship, and "was now one of the few unregulated spaces where radicalisation is able to take place".
But it added that a "sense of grievance" was key, and direct personal contact with radicals was a "significant factor".
The government's counter-terrorism strategy should show that "the British state is not antithetical to Islam", the committee said.
Keith Vaz, its chairman, said: "The conviction last week of four men from London and Cardiff radicalised over the internet, for a plot to bomb the London Stock Exchange and launch a Mumbai-style atrocity on the streets of London, shows that we cannot let our vigilance slip.
"More resources need to be directed to these threats and to preventing radicalisation through the internet and in private spaces. These are the fertile breeding grounds for terrorism."
The al Qaida-inspired fundamentalist group wanted to send five mail bombs to various targets over the 2010 festive period and discussed launching a "Mumbai-style" atrocity.
A hand-written target list found at one of the defendant's homes listed the names and addresses of London Mayor Boris Johnson, two rabbis, the American Embassy and the Stock Exchange.
The police counter-terror operation which led to their arrests was the biggest of 2010.
Vaz went on: "The July 7 bombings in London, carried out by four men from West Yorkshire, were a powerful demonstration of the devastating and far-reaching impact of home-grown radicalisation.
"We remain concerned by the growing support for non-violent extremism and more extreme and violent forms of far-right ideology."
He added that "a policy of engagement, not alienation" would prevent radicalisation and called for the government's counter-radicalisation strategy Prevent to be renamed Engage.
The committee also called for better information-sharing between prison bosses, the police and the UK Border Agency (UKBA) following the release of prisoners who have been convicted of terror offences.
But although several convicted terrorists have attended prisons and universities, "there is seldom concrete evidence to confirm that this is where they were radicalised", it added.
:: Terror plot "lynchpin" Mohammed Chowdhury, 21, of Stanliff House, Tower Hamlets, and his London accomplice Shah Rahman, 28, of St Bernard's Road, Newham, are expected to be sentenced to 18 and a half years and 17 years respectively.
The duo will only serve about six years because five are served on licence, prisoners only serve half their term as standard and they have already been behind bars for more than 12 months.
Two others, brothers Gurukanth Desai, 30, of Albert Street, and Abdul Miah, 25, of Ninian Park Road, both Cardiff, will also be sentenced at Woolwich Crown Court.
A Home Office spokesman said: "Prevent is an integral part of our counter-terrorism strategy and aims to stop people from becoming terrorists or supporting terrorism.
"Our new Prevent strategy challenges extremist ideology, helps protect institutions from extremists, and tackles the radicalisation of vulnerable people. Above all, it tackles the threat from home-grown terrorism on and off line. We are working closely with the police and internet service providers to take internet hate off the web.
"We are pleased the Home Affairs Committee and the witnesses who contributed to its report broadly support the outcome of the Prevent review and the revised strategy. This is an interesting report and we will consider its findings."
Nick Pickles, director of civil liberties and privacy group Big Brother Watch, said: "Whatever the reason for blocking online content, it should be decided in court and not by unaccountable officials.
"The level of monitoring required to police such a scheme would mean a significant invasion of every internet user's privacy.
"There is a serious risk that this kind of censorship not only makes the internet less secure for law-abiding people, but drives underground the real threats and makes it harder to protect the public."