WASHINGTON (Reuters) -- The issue of whether and how to suggest that Israel should be a Jewish state ultimately sank diplomatic efforts to draft a substantive statement to revive peace talks, sources familiar with the matter said.

The sources, speaking on condition of anonymity, said Israel and the Palestinians -- and their effective proxies in the negotiations, the United States and Russia -- remain too far apart on that issue and others.

The European Union, Russia, the United Nations and the United States -- known as the "Quartet" -- have tried for months to draft "terms of reference" that might breathe life into peace talks that collapsed nearly a year ago.

US President Barack Obama's administration pushed hard to dissuade President Mahmoud Abbas from seeking full UN membership, arguing that Palestine would become a state only through negotiations with Israel. Abbas rebuffed them and, on Friday, made a formal request.

The Quartet hoped to draft a statement with "terms of reference" to head off UN push by Abbas but when it became clear that was impossible, they chose to issue a statement on Friday designed to revive peace talks in spite of his request.

In a week of high-stakes diplomacy under the spotlight of the UN General Assembly last week, diplomats could not find a formula acceptable to both sides on the central issues: borders, Jewish settlements, the fate of Palestinian refugees and the status of Jerusalem.

Instead, they issued a statement that focused on process: calling for preparatory talks in a month, substantive proposals from both sides on borders and security within three months and a peace deal by the end of 2012.

Deep skepticism

There is deep skepticism among diplomats and analysts that serious negotiations will begin or, if they do, go anywhere.

Neither Israel nor the Palestinians have formally responded to the Quartet statement. On Sunday, Abbas repeated his unwillingness to resume talks without a freeze on the building of Jewish settlements.

Israeli Prime Minister Benjamin Netanyahu last year refused to extend a 10-month limited moratorium on settlement construction, prompting the Palestinians to abandon peace talks that had begun only a few weeks earlier.

"As well as being wrapped around the settlements freeze axel, we now seem to be wrapped around the 'Jewish state' axel too," said Martin Indyk, a former US assistant secretary of state for Near Eastern affairs now at the Brookings Institution think tank.

US officials originally hoped to enshrine a central bargain in the statement: that the borders of a Palestinian state would follow the lines prior to the 1967 war, with mutually agreed swaps, and Israel would be a Jewish state.

Israeli officials, including Netanyahu, find it hard to swallow the language on borders, arguing the 1967 lines will not preserve security and that it must be clear any border will differ from them.

The Palestinians find the idea of Israel as a Jewish state equally indigestible because it appears to give up in advance any "right of return" by Palestinians who fled or were forced to leave their homes as well as to compromise Israeli Arabs.

"The heart of the matter was that the only way in which it was going to work as a basis for negotiations was if there was a reference on the one side to '67 lines plus swaps, which was the minimum but not sufficient requirement for the Palestinians, and a Jewish state as one of the goals of the negotiations, which was the minimum requirement of the Israelis," said one source briefed on the negotiations.

"Although it was handled by proxies -- that is Russia and the United States -- what the Quartet statement revealed was the gap between the maximum concession that Netanyahu was willing to make and the minimum requirement that Abu Mazen (Abbas) would settle for -- maybe."

There are many formulas to address whether Israel should be viewed as a Jewish state, including that it is a homeland for the Jewish people or that it embodies the right of the Jewish people to self-determination or that its status as a Jewish state should not prejudice any Palestinian "right of return."

None appear to have sufficed, whether because they might be seen as unacceptable to the Israelis or because they would be impossible to swallow for the Palestinians.

'Less is more'

The result, sources familiar with the talks said, was a decision on Thursday evening to explore a statement that would focus on process rather than substance and to lay out a time-line for the parties to try to settle their differences.

Having failed to bridge the gaps, "there was nonetheless consensus that we should not leave these parties with nothing, that we should do something," said one diplomat familiar with the talks.

"There are times when less is more," said another diplomat familiar with the talks. "This was one of those times."

The whole issue is an election-year headache for Obama.

Having seen his Democrats lose a New York congressional seat to the Republicans for the first time since the 1920s -- partly because Jewish voters feel the president has not supported Israel strongly enough -- Obama is wary of alienating pro-Israeli voters before his 2012 re-election campaign.

While most sources said the main stumbling block was whether to refer to Israel as a Jewish state, one diplomat said that issue, the one about the 1967 borders with swaps and the question of Jewish settlements were "equally difficult."

Diplomats hope the compromise statement, shorn of the substantive language, may still give the Israelis and the Palestinians a way back to talks.

The three-month time-line for both sides to come up with "comprehensive proposals" on territory and security will also provide a barometer of whether either side is serious and, if they are not, show where the blame lies.

The initial signs are not hopeful that the parties will return to the table. Analysts and diplomats said it was likely a preparatory meeting would occur but less likely that formal talks could begin or, if they do, make much progress.

"I wouldn't rule out the preparatory meetings," said Daniel Levy, an adviser to former Israeli Prime Minister Ehud Barak who is now at the New America Foundation in Washington. "I do not see any real productivity coming from negotiations."