Reading DH's TOS, it seems that proxies are frowned upon for the often-excessive traffic they generate. Then there's the bit in section 7 about "The customer agrees to make use of DreamHost Webhosting servers primarily for the purpose of hosting a website, and associated email functions." That pretty much expressly rules out use as a proxy server and moots any whining about what's legal and what ain't.
I'd imagine, however, that any open proxy site (..especially those that have little or no restrictions on IPs that are allowed to connect and/or the ports that traffic is allowed to proxy) will soon find itself suspended for violation of any one of a number of DH's other policies. Even simple HTTP proxies can be used to generate/participate in DDoS attacks.
Of course, the OP didn't say what sort of traffic was being proxied, so kinda hard to pick and choose. If it didn't have any restrictions on which IPs were allowed to connect, then it can be used for nearly anything, including relaying for zombie nets and such.