The Colonial prison system is used to process and remove criminal elements from mainstream Colonial society.
Circa pre-First Cylon War YR42, a facility simply referred to as the Colonial Prison was located in Marathon (The Caprica: "V-Clubs: A Reality, Virtual and Otherwise").
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There are means to rehabilitate prisoners within this system so that they may be productive citizens, however these programs have a low success rate. According to figures roughly 13 years prior to the Fall of the Colonies, 63% of prisoners released from the prison system turn to a life of crime within the first five years after their release, and eventually end up back in the system.
Lower level prisons, such as those on Tauron, are meant to incarcerate prisoners who are not a serious threat. Such prison systems have facilities for solitary confinement and counseling.
Higher level prisons, such as Luna Three, are labor camps worked by "stumps". Life is harsher in these conditions, but installations like Luna Three are meant for more hardened criminals, like Tom Zarek or Darja Purat ("Battlestar Galactica: Zarek 3", "Battlestar Galactica: Season Zero 3").