Finance Minister Yuval Steinitz says he is delaying a cash transfer to the Palestinian Authority because of a new unity deal between rival Palestinian factions.
Steinitz says he will hold up the transfer of $89 million in Palestinian tax funds and customs fees that Israel collects on the Palestinians' behalf.
Steinitz told Army Radio on Sunday that the money was supposed to be transferred this week but would remain in Israeli hands until it was clear it would not reach the militants of Hamas.
Last week the Palestinians announced a new unity deal between the Western-backed Palestinian Authority and the Iran-backed Hamas, which rejects any accommodation with Israel.
The Israeli government says it will not negotiate with a government that includes Hamas.
A senior Palestinian official in the West Bank condemned the move, saying Israel had no right to withhold Palestinian funds.
"Israel has started a war even before the formation of the government," senior Palestinian official Saeb Erekat said.
The finance minister said that the issue could be reconsidered "if the Palestinians can prove to us ... that there is not a joint fund between the Palestinian Authority and Hamas in Gaza."
"We ask the entire world not to fund Hamas, so we must not do so, even indirectly," he said.
Steinitz noted that Israel had withheld the tax revenues in the past, during a Palestinian uprising that began in 2000.
Prime Minister Benjamin Netanyahu recently hinted to a visiting delegation of U.S. Congress members that the United States should consider stopping economic aid to the Palestinian Authority if a Hamas-Fatah unity government did not recognize Israel and renounce terror.
Speaking to the American legislators, Netanyahu quoted remarks by Secretary of State Hillary Clinton in April 2009, that Israel would not hold talks with or economically support a Palestinian government, including Hamas, until Hamas recognized Israel and abandoned violence.