Under pressure from Washington, interim Prime Minister Ehud
Olmert approved the transfer of nearly US$55 million (A$73.09 million) to the Palestinian Authority.
But he says Israel will now decide on a month-to-month basis whether to make any future tax payments and cooperation in other areas will also be re-evaluated.
Israel had been scheduled to transfer the money to the Palestinian Authority last Wednesday but announced at the time that it had decided to suspend automatic payments pending a policy review after Hamas won the January 25 election.
The United States had urged Israel to keep handing over monthly customs revenues it collects on behalf of the Palestinian Authority at least until Hamas, which has called for the destruction of Israel, enters the government.
Completing the review, Mr Olmert's cabinet decided to transfer the sum Israel owed for January, minus a collection fee and deductions for Israeli electricity and healthcare services used by Palestinians, a government official said.
Parliament to convene
"Since Hamas hasn't yet set up a government and the new parliament is not yet sworn in, every month we will take a new assessment," Mr Olmert told ministers.
He said Israel would no longer make the monthly tax payment transfers automatically, and that this reassessment would also apply to past agreements with the Palestinians for building a Gaza seaport, and new desalination and sewage plants.
Israel's cabinet had also decided not to let members of the Palestinian parliament travel from the Gaza Strip to Ramallah in the occupied West Bank for their swearing in.
A Hamas leader said on Sunday that the group hoped to form a government this month. Parliament is to convene on February 16.
Announcing the decision to transfer the tax, cabinet minister Zeev Boim said: "It looks like it will be the last payment before a Hamas government is formed as Hamas does not seem to be changing its position with regard to Israel."
The tax revenues Israel collects on behalf of the Palestinians are a main source of funding for the Authority's budget and are used to pay 140,000 government workers.
"This is our money. This is not a favour," Palestinian Economy
Minister Mazen Sonnogrot said after the decision. "I hope that such payments will continue in the future."
To make up for lost revenue, the Palestinians have said they hope to receive cash soon from Saudi Arabia and other Arab states.
Pilfering charges
The Palestinian Authority runs on a budget of about A$133 million a month. In addition to the taxes collected by Israel, it receives about A$1.33 billion a year from international donors.
Meanwhile it has been disclosed that Palestinian Authority officials had stolen or squandered at least A$930 million from its coffers over the past few years.
At a news conference in Gaza, Palestinian Attorney-General Ahmed al-Moghani said 25 officials had been arrested and 10 had fled abroad in a corruption investigation.
Rockets and airstrikes
In a surge of violence two Palestinian militants were killed in an Israeli air strike on Gaza on Sunday, the second deadly attack in 24 hours as leaders of Hamas gathered in Egypt to discuss policy towards the Jewish state after their election victory.
Both men killed in the strike on two cars in the Zeitun neighbourhood of Gaza were members of the armed wing of Islamic Jihad, one of the militant groups which has stopped observing a truce with Israel, Palestinian security sources said.
One, Adnan Bustan, was believed responsible for the manufacture of rockets used by Jihad militants to fire at Israel.
An Israeli army spokesman confirmed that a raid had been carried out targeting Islamic Jihad militants.
Their deaths brought to 4,944 the overall toll since the September 2000 launch of the intifada, the majority of them Palestinian, according to a tally by news agency AFP.
The raid followed the killing of three Palestinian militants overnight in
Israel's first air strike on the Gaza Strip since Hamas's sweeping victory in parliamentary elections last month.
The trio belonged to the Al-Aqsa Martyrs' Brigades, an armed offshoot of the Palestinian leadership's long dominant Fatah faction.
The first air strike drew sharp condemnation from Hamas, which immmediately asserted the Palestinians' "right to self-defence".
"People have the right to defend themselves in the face of these acts by the occupation," top Hamas leader Ismail Haniya told AFP.
Israel said the raid which targeted a building in Gaza City was in response to a rocket attack on Friday which injured four Israelis.