Israel branded the Palestinian government a "terrorist authority" Sunday and halted the transfer of hundreds of millions of dollars in tax money after Hamas took control of the Palestinian parliament.

But the Israeli government held off on adopting even more drastic measures recommended by security officials, mindful of possible international reaction.

The sanctions came as the Palestinian militant group worked to consolidate its power and form a government, nominating one of its more pragmatic leaders, Ismail Haniyeh, to be the new prime minister.

Mahmoud Abbas, president of the Palestinian Authority, was scheduled to meet with Haniyeh in Gaza on Monday and formally ask him to assemble a Cabinet. Haniyeh said Hamas would begin talks with possible coalition partners Monday.

The Islamic group, which calls for the destruction of Israel and has carried out scores of deadly suicide bombings against Israelis, trounced Abbas' corruption-riddled Fatah Party in Jan. 25 elections, winning 74 of 132 parliament seats.

Israel and Western countries demanded the group renounce violence and recognize Israel's right to exist, but Hamas resisted pressure to moderate. The group took control of the Palestinian legislature when the new parliament was sworn in Saturday.

"The PA is — in practice — becoming a terrorist authority," acting Israeli Prime Minister Ehud Olmert told his Cabinet at the beginning of its meeting Sunday. "Israel will not hold contacts with a government in which Hamas takes part."

The Cabinet decided to stop the transfer of the roughly $55 million a month it collects in taxes and tariffs on behalf of the Palestinian Authority. The order did not specify when the payments would stop, but government spokesman Asaf Shariv said the next payment, scheduled for early March, "won't take place."

Army Radio quoted Defense Minister Shaul Mofaz saying the cutoff would be reviewed each month.

The Palestinian Authority relies on that money to help pay the salaries of roughly 140,000 government employees, including about 57,000 in the security forces.

Should the government, the Palestinians' largest employer, be forced to lay off tens of thousands of workers, it would lead to increased chaos and poverty in Palestinian towns throughout the West Bank and Gaza.

Palestinian experts estimate that the Palestinian budget shortfall is about $1 billion a year, and the Israel-collected funds would cover about half of that.

However, the Cabinet held back from adopting far harsher proposals made by Israeli security officials, including a recommendation to seal off the Gaza Strip, barring thousands of Palestinian laborers from entering Israel and eliminating all trade with the impoverished area.

Israel's acting foreign minister, Tzipi Livni, said the government did not want to worsen the daily lives of Palestinians or cause an international backlash against Israel.

But she warned that "Israel will take a number of additional politically significant steps regarding the Palestinian Authority." She did not elaborate.

Mofaz told Israel TV the government could freeze work on the construction of a seaport and airport in Gaza.

The Cabinet also decided to ask the international community to stop giving money to the Palestinians, though it said humanitarian aid should continue. Hamas is listed as a terror organization by the United States and the European Union, and many Western countries have threatened to cut off hundreds of millions of dollars in funding for the Palestinian Authority if the group does not moderate.

On Sunday, Abbas said the Palestinian government has agreed to return $50 million in special aid given by the U.S. government, as requested by the United States after Hamas' election win.

Abbas criticized reaction to the Hamas ascension to power. "We chose in free elections that the whole world witnessed were free and fair," he told reporters in Gaza.

Abbas said aid cuts are already being felt. "We are in real financial crisis," he said.

Hamas condemned the Cabinet decision, calling it "collective punishment" and saying it was political posturing ahead of Israel's own election on March 28.

He told Al-Jazeera TV, Israel should instead "deal with reality on the basis that there are people who are looking for rights, a state, return (of refugees), freedom and dignity."

The head of the Arab League, Amr Moussa, said Sunday that Arab governments were considering providing the money to make up for the frozen transfers from Israel. Arab governments have not been among the top donors to the Palestinian Authority in the past, and some have failed to give pledged funds.

Early Monday, Israeli forces in Nablus shot and killed a senior member of Islamic Jihad, Palestinians said. The Israeli military said according to initial reports, Israeli soldiers opened fire on armed Palestinians, killing a Fatah militant.

On Sunday, Israeli troops killed four Palestinians in separate incidents.

Military officials said an Israeli aircraft attacked two Palestinians laying a bomb in the Gaza Strip, near the border with Israel. Two militants were killed, Palestinian security officials said.

Later, Israeli troops killed two Palestinians in the Balata refugee camp in the northern West Bank. Palestinian witnesses said the 17-year-old youths were shot after throwing rocks at soldiers. The army said they were planting a roadside bomb.