Prisoners will no longer live a life of "enforced, bored idleness" and instead be forced to work to pay compensation to their victims, Ken Clarke has said.
The Justice Secretary said he wanted prisons to become "tough places of hard work and reform" and ensure more private firms are brought in to rehabilitate offenders on a payment by results system.
Too many prisoners existed in a system where getting out of bed was "voluntary" and instead they should work nine to five jobs to gain a trade or skill, he told activists at the Conservative Party Conference in Birmingham.
Mr Clarke wants private firms to create the jobs for criminals and is even looking at the possibility of creating purpose-built workplace prisons where higher wages could generate even more cash.
Around one pound in five would be put in a fund for victims, with the rest used to cover the cost of keeping people behind bars, pay the benefits of prisoners' families or kept in trust for when they are released.
The Ministry of Justice is looking for around £2 billion of savings from its budget as part of the drastic Whitehall-wide spending review ordered by Chancellor George Osborne to tackle the UK's deficit.
Mr Clarke's push for greater emphasis on rehabilitation and community sentences in place of short sentences in an attempt to cut the record prison population is not popular with many Tory activists.
But he told the conference: "Don't worry, I haven't suddenly become in my old age some kind of woolly-minded idealist."
He added: "Let me be clear about what I have always said and always believed about crime and punishment.
"For serious criminals, prison is the best and only sentence. It is the punishment for serious crime that society expects and accepts.
"Career criminals and violent, dangerous criminals should be in prison - not roaming our streets."
Outlining his plans he said: "We need reform that is radical and realistic. Reform focused on results, not processes, not spin doctor headlines.
"My aim is to make prisons tougher places of hard work and reform for the criminals who should be locked up, make community sentences that really are tougher and more effective for those who don't need to be locked up, and cut crime creation out of the criminal justice system by paying by results organisations and investors who actually succeed in reducing reoffending.
"We need in my opinion, to instil in our jails, a regime of hard work. Most prisoners, not really their fault, lead a life of enforced, bored idleness, where for the majority of them even getting out of bed is voluntary.
"If we want to reduce the crimes these people will commit when they get out, we need as many as possible to get used to working hard for regular working hours.
"The ones prepared to make an effort need new opportunities to learn a trade. We have to try to get those with the backbone to go straight, to handle a life without crime when they have finished their punishment.
"So we will make it easier for prison governors to bring more private companies into jails to create well-run businesses employing prisoners in nine-to-five jobs with a working routine."
Mr Clarke said he had never been in favour of "mollycoddling criminals". He said: "Dangerous offenders must always, and will always be punished with prison.
"But let us not deceive ourselves that the previous government left 85,000 serious gangsters in prison, that our prisons are only populated by muggers, burglars and violent and dangerous individuals."
He said there were 11,000 foreign prisoners in jail and thousands of petty criminals who "fail to behave themselves in everyday life". Almost half were illiterate or innumerate and almost half had a mental illness.
Too many went into prison without a serious drug problem and came out as addicts. He wanted to see drug-free wings in a bid to stamp out the "drugs menace".
Mr Clarke said under Labour, prison numbers had shot up by a third and spending on prisons had increased by a third as well.
He revealed that in 2008, 53,000 criminals were jailed for less than six months and nearly two thirds of them were back in prison within a year. This was an "absurd" situation, he claimed.
On bringing in more private firms into the prison system he told the conference: "When we consider how to reduce re-offending by rehabilitating released prisoners or providing tougher community sentences, I am interested in one thing - what works.
"Value for taxpayers' money is best achieved by paying - not for good intentions - but for results.
"We will pay for fewer crimes. Fewer victims. We can challenge the independent sector, charities, voluntary bodies, the private sector and the public services. You develop schemes that do cut reoffending, in prison or in the community, and we'll pay you to do it if and when it works."
He said this could include the range of schemes from boot camps to therapy, the key was that the programmes could show they were achieving results.