Sept. 21 (Bloomberg) -- Israel may withhold as much as 40 percent of Palestinians' financial revenue should they persist in pushing for a vote on statehood at the United Nations, Finance Minister Yuval Steinitz said.

"It will be very difficult for us to continue to collaborate with a hostile Palestinian entity," Steinitz, 53, said in an interview yesterday at Bloomberg's headquarters in New York. "Maybe we will tell the Palestinians 'Okay, collect your own tax. Why should we do it for you?'"

Israel collects about $1.2 billion in fees each year for the Palestinian Authority and has withheld the money in the past during disputes with the Palestinians. Both the U.S. House of Representatives and Senate have called on President Barack Obama to reduce the Palestinians' annual $500 million in foreign aid if they proceed at the UN's September meeting.

"It's not up to me alone to make the decision, but in my view if they want to use their automatic majority in the UN then I think we won't be able to cooperate with such an assault on Israel's very legitimacy," he said. "We are concerned about the Palestinian attempt to betray the very essence of the peace process."

Steinitz was appointed finance minister at the end of March 2009, when Prime Minister Benjamin Netanyahu's government took office.

Economic Arsenal

Israel's ability to hurt its neighbor economically is a key tool the Jewish state has at its disposal to try and dissuade Palestinian Authority President Mahmoud Abbas on Sept. 23 from asking the UN Security Council to recognize a Palestinian state and accept it as a full member. As Israel's top ally, the U.S. has said it would use its veto power in the 15-member UN body to prevent Abbas from reaching his goal.

"Everything depends on continuation of aid and the Palestinians being able to access their own money from the Israelis, in terms of stability and keeping things calm on the ground," said Hussein Ibish, a senior fellow at the American Task Force on Palestine, a Washington-based group that advocates for a peaceful end to the conflict. "The grimmest scenario is the U.S. and Israel both deciding to punish the Palestinians."

U.S. assistance to the Palestinians for 2010 totaled $740 million, directly and through organizations including UN aid agencies, according to a State Department fact sheet. Israel's champions in the U.S. Congress have threatened to cut aid to the Palestinian Authority as punishment for seeking a UN vote.

Obama Support

For Obama, who is scheduled to meet in New York with Netanyahu yet not Abbas, the pressure to be seen as unwaveringly on Israel's said is mounting ahead of 2012 elections. Republican presidential candidate Rick Perry said yesterday that Obama's policy in the Middle East was "naive, arrogant, misguided and dangerous."

Palestinian negotiator Mohammad Shtayyeh on Sept. 13 dismissed concerns the U.S. would cut funding if the Palestinians go to the UN. He also suggested Israeli threats to retaliate by holding back tax and customs revenue collected on behalf of the Palestinians shouldn't be taken seriously.

"Cutting off funds to the Palestinians carries with it a lot of repercussions that are not exactly in favor of Israel," said Marwan Muasher, a vice president at the Carnegie Endowment in Washington and Jordan's first ambassador to Israel. "If the Palestinian people see that their lifeline is cut off by Israelis, that might be the trigger for large-scale demonstrations in the West Bank and Gaza, especially in the context of what's been happening in the Arab World."

No Annexation

Steinitz also said retaliation from Israel won't go as far as annexing the West Bank, as called for by some members of Netanyahu's ruling Likud party.

"I don't think that this will be our reaction," he said. "Maybe because we always want to leave room for the future peace process."