A two-year congressional review of policy toward American Indians has recommended that tribes be given full legal power to run their own affairs, including the right to tax citizens, try offenders in tribal courts, and control waterways, fishing and hunting on their reservations.

A report to be released this week by the American Indian Policy Review Commission asserts that federal policy ought to guarantee that tribal governments have all the power now held by non-Indian local governments.

It also strongly criticizes the Bureau of Indian Affairs for misrepresenting Indians, and proposes that it be replaced by an independent agency. The Department of the Interior, which now includes the BIA, has too many conflicts of interest with its land and water programs to defend Indian rights fairly, it concludes.

The report's more than 100 recommendations, many of them controversial, propose a radical transformation of Indian rights, supporting almost all of the Indian claims to tribal sovereignty that have become popular since the late 1960s.

Many recommendations conflict directly with non-Indian interests. The right to try non-Indians in tribal courts is opposed in a series of court tests now under way. Tribal trials of non-Indians should be a long-range goal but not a priority matter for legislation, the report states.

Whites who live on or near Indian reservations in the West have resented tribal attempts to impose the taxes and business licenses that the commission said are proper. In addition, white commercial interests in the West are frequently in conflict with Indians over water rights. The commission recommends control by tribal councils over water on their reservations.

The commission, established by Congress in 1975, includes five tribal representatives and six members of Congress. Its chairman is Sen. James Abourezk (D.S.D.). The report is to be circulated to 1,100 organizations for comment before going to Congress on May 18. Its charter stipulates that congressional committees must consider the recommendations within two years.

A strong dissent was filed by one member, Rep. Lloyd Meeds (D-Wash.). He said the report calls for "an unwarranted extension of the concept of sovereignty which Indians have been trying to forward for some time and some of its suggestions are so unrealistic as to subject it to ridicule. For example, it suggests that Indian tribes have jurisdiction over non-Indians on reservations -- to tax them. I am violently opposed to that. Non-Indians don't have any participation in the decision-making. You know we fought a revolutionary war over that."

The review's most stinging criticism is reserved for the Bureau of Indian Affairs, with which many tribes have been feuding for years. It accuses the bureau of interfering in tribal elections, playing one tribe against another in competition for federal funds, making business contracts without tribal approval, advising Indians to sell their land in order to qualify for welfare, and mismanaging tribal trust assets. The BIA, it said, is neither "accountable nor responsible" to tribal governments.

Of Interior's conflicting interests, the commission said, "One cannot reconcile, for example, the functions of the Bureau of Land Management and the Bureau of Fish and Wildlife with the requirements of the trust to protect the Indian land base, forestry and mineral resources, hunting and fishing rights."

The solution would be an independent agency or department exclusively devoted to Indian affairs, with a fully staffed legal office to represent Indian rights in court, the report said.

Interior Secretary Cecil D. Andrus has promised Indian leaders more influence within the present department and has indicated he will create a new post of assistant secretary to oversee the BIA.He has invited tribal leaders to suggest candidates for the job.

The commission also recommended that all federal assistance funds be distributed directly to tribal governments. Some are sent directly now, but many are channeled through state governments.