The report, which comes after an investigation by committee members who visited Iraq in December, accuses US occupation forces of supporting the Shia and Kurds at the expense of Arab Sunnis.
It reveals fears by Arab countries that the policy will split Iraq into several minor statelets along sectarian or ethnic lines.
A federal state based on de-facto ethnic and sectarian divisions in Iraq would represent the first step towards the country's break-up.
Such a turn of events would pose a direct threat to many Arab countries, which contain minorities that might ask for similar deals.
The report argues that the composition of the Iraqi Governing Council (IGC), corresponding to the country's ethnic make-up, has laid the foundations for sectarianism.
The report, however, has come under fire from some members of the IGC.
"Statements and comments made by the fact-finding members are recorded and well documented by us," said Adil Murad, a representative for the IGC member Jalal Talbani of the Patriotic Union of Kurdistan (PUK).
"They are totally different from what has been released in the report."
Murad denied Kurdish separation attempts and expressed doubts that the assistant secretary-general of the Arab League, Ahmad bin Hilli, had written the report.
"Bin Hilli stressed Kurdish rights when he visited Halabja and condemned the former Iraqi government for using chemicals against Kurds," Murad said.
He confirmed that the IGC will be sending a letter of objection to the Arab League if Bin Hilli is found to have written the report.
Arab League spokesman Husam Zaki said the report aimed to brief Arab League members about the situation in Iraq, adding that it was not intended to blame any particular party.
Bin Hilli headed the 10-day fact-finding mission which met with Iraqi politicians, clerics, and tribal leaders.
The report will be discussed in the upcoming Arab Summit.