President Bush allowed security agents to eavesdrop on people inside the US without court approval after 9/11, the New York Times has reported.
One of Bush's top aides says he did not break the law
Under a 2002 presidential order, the National Security Agency has been monitoring international communications of hundreds in the US, the paper says.
Before, the NSA had typically limited US surveillance to foreign embassies.
Questioned about the report, Condoleezza Rice said Mr Bush had never ordered anyone to do anything illegal.
But some NSA officials familiar with the operation have questioned whether the surveillance of calls and e-mails has crossed constitutional limits on legal searches, according to the Times.
American law usually requires a secret court, known as a Foreign Intelligence Surveillance Court, to give permission before intelligence officers can conduct surveillance on US soil.
When asked about the programme on US TV, the secretary of state, Condoleezza Rice, said: "The president acted lawfully in every step that he has taken".
"He takes absolutely seriously his constitutional responsibility both to defend Americans and to do it within the law," she said.
She declined to discuss details of the New York Times report.
The newspaper said nearly a dozen current and former administration officials discussed the programme with reporters.
They were granted anonymity because of the classified nature of the scheme.
Under the programme, the NSA has eavesdropped on as many as 500 people inside the US at any given time in its search for evidence of terrorist activity, the paper said.
Overseas, 5,000 to 7,000 people suspected of terrorist ties are monitored at one time.
"This is really a sea change," a former senior official who specialises in national security law told the paper.
"It's almost a mainstay of this country that the NSA only does foreign searches."
The New York Times said it delayed publishing the information on the move for a year, in response to White House concerns it could jeopardise investigations.
Some officials said the programme had helped to uncover several terror plots, including one by an Ohio lorry driver who was jailed in 2003 for supporting al-Qaeda and targeting a New York bridge for sabotage.
'Above the law'
Officials cited by the paper said the Bush administration saw the scheme as necessary to disclose terror threats.
However, the paper reported that questions about the legality of the scheme led the Bush administration to suspend it temporarily last year and impose new restrictions.
The American Civil Liberties Union (ACLU) said eavesdropping in the US without a court order and without complying with the procedures of the Foreign Intelligence Surveillance Act was "both illegal and unconstitutional".
"The administration is claiming extraordinary presidential powers at the expense of civil liberties and is putting the president above the law," director Caroline Fredrickson said.
The group called on Congress to investigate the report.
The Bush administration has faced opposition over some anti-terrorism initiatives in the past, such as the Patriot Act, which is up for renewal by Congress.
The law grants government agencies extraordinary powers to spy on and prosecute those suspected of terrorism.
Opponents say many of its provisions infringe civil liberties.