Armed police shouted "put the gun down" before shooting a 24-year-old man who was reported to be holding a handgun, a local resident said.
Officers were called to Frenchmans Way, South Shields, South Tyneside, shortly after 1am where the man was shot once, then taken to hospital.
The Independent Police Complaints Commission has begun an investigation, which is standard procedure when someone is shot by officers.
A local father, who did not give his name, said his girlfriend heard police shout: "Put the gun down," and she heard a bang, which she thought was a firecracker at first.
The man said: "I came out and there were police with guns walking up and down in body armour, like they were securing the area.
"I thought they were looking for a gunman.
"Police were working on the man for about 10 minutes, giving him oxygen. Then they let the ambulance in and after about five minutes they took him to hospital."
The witness said locals thought the man was shot in the chest.
The man believed he knew the identity of the person shot by police.
"He is a respectful kid, he puts his head down when he walks past you," he said. "He is a decent enough bloke."
The witness said the man who was shot was not a gangster.
"I was thinking: who is daft enough to wave a gun around here? And the man is not that type of person," he said.
"If someone said 'Boo' to him, he would run as fast as he could.
"Maybe he was full of drink - it will all come out in the end.
"I hope he is all right."
Northumbria Police said officers were responding to reports that a man had been seen with a handgun.
A spokesman said: "The 24-year-old man has been taken to hospital with a single gunshot wound and is currently receiving treatment."
Investigators have placed up to eight yellow markers on the street indicating where evidence has been left.
A forensic officer in a white suit was working on the ground to examine the scene.
Frenchmans Way was cordoned off with uniformed officers standing guard.
A local mother, who asked not to be named, said: "For someone to be waving a handgun in the street where people live, it's just disgusting.
"It's an absolute disgrace when it's on your doorstep."
She heard sirens in the night but the first she heard of a shooting was when she saw the news on Facebook when she got up.
Two women who worked the night shift at a local care home said they heard a single bang in the night.
An investigator in an orange IPCC jacket carried evidence away in a large brown paper sack to a van, and a police photographer took photos of the road surface.