"For Israeli archaeology, this is the first mention in Hebrew of the city of Jerusalem outside the New Testament," Amir Ganor of Israel's antiquities authority told AFP as the papyrus was presented in Jerusalem.
The antiquities authority said the papyrus, found near the Dead Sea, was seized from traffickers after a lengthy investigation as it was about to go on sale on the black market.
It proved that "Jews were in this city 2,700 years ago," said Ganor.
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He said the timing of the announcement, amid a row with the United Nations Educational, Scientific and Cultural Organisation, was a coincidence as it had been held up by the trafficking investigation.
A UNESCO resolution passed on October 18 criticised the Jewish state for restricting access to the Al-Aqsa mosque compound in annexed east Jerusalem, angering Israel which said it denied Judaism's historical connection.
Culture Minister Miri Regev pounced on the find as "proof that Jerusalem has been and will forever remain the eternal capital of the Jewish people".
Israel is furious that the UNESCO resolution refers to the holy site in Jerusalem's Old City only by its Muslim name, Al-Aqsa or Al-Haram al-Sharif.
Jews refer to the site as the Temple Mount and it is considered the holiest site in Judaism.