The Office of Fair Trading should investigate the impact of town hall-funded freesheets on local newspapers, a committee of MPs said today.
The Culture, Media and Sport Committee also called for a relaxation of OFT rules which prevent news organisations working together to fight off challenges from internet services like Google News.
Releasing a wide-ranging report on the future for local and regional media, committee chairman John Whittingdale said the industry was facing "unprecedented challenges".
He said: "This has led to the closure of a large number of newspapers, many commercial radio stations becoming loss-making and the possible end of regional news on commercial television.
"This has serious implications for local democracy."
The committee said it was concerned about the growing number of local authority publications that are competing with commercial local newspapers.
It said some are "misleading in nature" by failing to make clear they are council publications and some have also shown evidence of political bias.
The MPs recommended making it mandatory that the publications clearly state on their front page that they are published by a local authority.
Mr Whittingdale said: "There is a real problem with local authority newspapers and magazines that needs to be addressed.
"We have seen council newspapers that are effectively posing as, and competing with, local commercial newspapers.
"While it is important that local authorities communicate with their citizens, it is unacceptable that councils can set up publications in direct competition to local newspapers and that act as a vehicle for political propaganda."
On the issue of news aggregation websites, such as Google News, the committee said it is "not acceptable" that the local newspaper industry is prevented by competition laws from taking collective action and has recommended that the OFT should re-examine the issue.
The committee ruled out state subsidies for newspapers and urged publishers to "innovate to survive" by continuing to develop websites and utilising internet technologies.
It also called on the Government to re-examine the current merger rules to allow consolidation.
On the future of ITV's regional news, the committee said the situation is in danger of reaching a "crisis point" that could jeopardise the plurality of regional television news.
It recommends removing or reducing ITV's public service broadcasting obligations and other regulatory burdens if it is not financially viable for existing licensees to continue to provide regional news.
The report also re-stated the committee's support for the principle of using public funding to support Channel 3 regional bulletins.