Israel has decided to suspend the payment of taxes and customs duties to the Palestinian Authority, a spokesman for acting PM Ehud Olmert has said.
Israel says the tax and customs revenues will be held in trust
Ranaan Gissin told the BBC payments would cease because the Palestinian militant group, Hamas, had won last week's parliamentary elections.
The Oslo accords oblige Israel and the PA pay each other for various services.
Palestinian Economy Minister Mazen Sunnuqrut has said such a move would be an "irresponsible and grave decision".
Mr Sunnuqrut said the move amounted to collective punishment.
"This is our money and Israel is not a donor country," he told Reuters news agency.
"Israel should immediately release the money because it belongs to the Palestinian people."
A payment of about $55m, needed to pay the salaries of 130,000 Palestinian civil servants, was due to be given to the Palestinian Authority on Wednesday.
Population: 3.6 million
GDP per person: $934
Foreign aid per person: $469
Change in GDP per person since 1999: -38%
Poverty rate: 48%
Unemployment rate: 27%
Source: World Bank
But Mr Gissin said no payments would be made for now as Hamas was a "terrorist group".
The payments will resume when a policy review ordered by Mr Olmert has been completed. Until then, the tax revenues will be held in trust.
Two days ago, the European Union said it would carry on funding the Palestinian Authority for the time being, but it called on Hamas to renounce violence and recognise Israel.
President Bush made a similar demand in his State of the Union address on Tuesday.
Hamas has rejected such demands and says it will seek alternative sources of funding.
Delegations from the group have been sent on a tour of Arab states to urge them to maintain their financial support.
"The tour will aim to clarify Hamas's position based on its election agenda and to press Arab countries to continue with financial aid to the Palestinian people," Hamas spokesman Sami Abu Zuhri said.
But one Arab state has echoed the demands of the international community.
The head of Egyptian intelligence, Omar Suleiman, said Hamas should renounce violence and recognise Israel before it is allowed to form a new government.
Mr Suleiman, who has brokered past Israeli-Palestinian deals, was speaking after Palestinian President Mahmoud Abbas met Egyptian President Hosni Mubarak.