The shadowy former Equality minister filmed the incident, which happened on Sunday afternoon in London’s Hackney district.
She said the police arrested her “black friend” who was driving a “nice car” and interrogated her while she was in the passenger seat.
In footage recorded by Ms Butler, police said they were searching the area for “gang and knife crimes.”
Ms Butler told Sky News she was “angry and annoyed” by the incident, saying the Metropolitan Police had a “cancerous” problem related to institutional racism.
She said: “We were arrested because we are two black people driving a nice car in Hackney.
“I’m angry because I know this happens all the time every day. And people don’t know why they were arrested.
“There is a group of people who are disproportionately controlled.
“I wasn’t going to go online with that, but the policewoman ignited the situation. I was getting pissed off and angry with the way she was treating me.
“It’s tiring and exhausting and mentally draining if you’re black and treated like that. Yes, there are issues, but deal with them fairly, impartially and not racistically.
“If you profile cars because they’re not local, that’s a ridiculous way to police. If you stop cars because of the make, that’s a ridiculous way to police. And if you stop cars because of the color of the people inside, that’s racist. ”
The Brent Central MP said she had been “arrested several times” by police since her election as a member of parliament.
Sky News has contacted the Metropolitan Police for comment.
Writing on Twitter, Chief Superintendent Roy Smith said he spoke to Ms Butler on the phone, adding that “she gave me a very balanced account of the incident.”
“She was positive about an officer and gave her opinion on others and the judgment,” he wrote.
“We are listening to these concerns and Dawn has every right to raise them. ”
Metropolitan Police Commissioner Cressida Dick last month apologized to British sprinter Bianca Williams after she and her partner were handcuffed during a stop and search.
Williams has claimed officers racially profiled her with Ricardo dos Santos during the traffic stop in Maida Vale, west London, which saw the couple be separated from their three-month-old son.
Met police referred to police watchdog over the incident.