Prime Minister Benjamin Netanyahu of Israel seems determined to escalate a crisis by retaliating against the Palestinians after the United Nations General Assembly voted to elevate Palestine to observer state status.

Instead of looking for ways to halt a downward spiral, Mr. Netanyahu on Monday defiantly dug in on his plans to build 3,000 more housing units in contested areas east of Jerusalem and in the West Bank, and to continue planning a development in the most contentious area known as E1.

Israel also announced that it was withholding $100 million in tax revenues that it has collected from the Palestinian Authority, which is financially strapped. The moves would impose devastating penalties on the only officially recognized representative of the Palestinian people and could doom the chances for a two-state solution because building in the E1 area would split the northern and southern parts of the West Bank. Such measures are puzzling after Israel disparaged the United Nations vote as insignificant.

Some American lawmakers are also in a vengeful mood, threatening to close the Palestine Liberation Organization’s office in Washington, deprive the Palestinians of American aid and withhold financing from United Nations affiliates that accept the Palestinians as members. These actions would only harm Israel and further undermine America’s ability to play a credible mediator in any peace effort.

Mr. Netanyahu’s punitive, shortsighted moves threaten to crush the Palestinian Authority, and its president, Mahmoud Abbas, who has recognized Israel’s right to exist and represents the only credible peace negotiator.

Expanding West Bank settlements makes it nearly impossible to restart peace negotiations. Worse, it is a terrible distraction from the Iranian nuclear issue, which Mr. Netanyahu considers the main strategic threat to Israel. His actions have unwisely alienated the European Union, which has been crucial to pressuring Iran to abandon its nuclear program. Britain, France, Spain, Sweden and Denmark on Monday summoned the Israeli ambassadors in their capitals to protest Israel’s settlement plans.

The plan to develop E1 is particularly disturbing because the Obama administration, like others before it, have considered expansion there fatal to a two-state solution. Mr. Netanyahu is up for re-election in January, so he may be driven by his political needs. But that is no excuse.

The administration firmly condemned the moves, but Mr. Obama needs develop a new strategy for reviving peace talks, even though many despair of any success. He can start by urging Mr. Netanyahu to drop the settlement plans and Mr. Abbas to forgo applying for Palestinian membership in United Nations affiliates or trying to bring cases against Israel in the International Criminal Court.