Plans to build a 600 capacity prison on Merseyside have been cancelled, the Ministry of Justice (MoJ) has said.
Proposals to build a jail in Maghull, near Ashworth High Security Hospital, were first put forward by the former Home Secretary John Reid in 2007.
Serco Group plc, the preferred bidder on the contract to build the prison, has been told that it has been axed.
A ministry spokesman said the budget deficit and an overhaul of the prison system were major factors.
He added: "We will now look in detail at the sentencing frameworks for adults and young offenders, and the full range of penalties currently available to sentencers.
"We will also look to overhaul the system of rehabilitation to reduce re-offending.
"Long-term decisions on prison capacity programmes will be taken in the light of future policy developments and a projected fall in the number of offenders in custody."
Last week, Justice Secretary Ken Clarke promised to end the rise in prisoner numbers and "break the cycle" of crime by tackling the causes of reoffending.
His Green Paper on sentencing in England and Wales aims to cut the 85,000 inmate population by 3,000 by putting "more emphasis on reducing reoffending without reducing the punishment of offenders", he said.
Despite the cancellation of the project, Serco Group said it hoped to work with the government on its alternative plans for criminals.
"We fully understand the Ministry of Justice's decision to cancel the Maghull prison project," said a spokesman.
"We look forward to working with the government on its proposals to deliver innovative, effective rehabilitation to reduce reoffending."