MIGRON, West Bank (Reuters) - The Jewish settlement of Migron perches high on a blustery hill in the occupied West Bank. Its inhabitants pay taxes, are hooked up to the electricity grid and get round-the-clock protection from Israeli soldiers.

Over the past decade the government has spent at least 4 million shekels ($1.1 million) on establishing and maintaining the cluster of squat, prefab bungalows, even building a neat tarmac road up the steep incline to the treeless ridge.

Yet despite all that state help, Migron is an illegal outpost, even under Israeli law, and its time is running out.

In an unprecedented ruling in August 2011, Israel's Supreme Court told the government to evacuate Migron by March 31, 2012. The land, the court said, belonged to Palestinians.

The judgment highlights a fundamental contradiction at the heart of the Jewish state - despite publicly endorsing the notion of an independent Palestinian nation, successive Israeli governments have nurtured illegal outposts on the very land that the Palestinians claim as theirs.

What becomes of Migron is important not just to the settlement movement but also to Middle East peace.

Its passionate young inhabitants - the vast majority of whom are under 30 - dispute the evacuation order and refuse to move. The Israeli government wants to delay any eviction, but the court ruling stands. Something has to give, and soon.

"This place was built entirely with the help of the government. It is inconceivable that the state should now force us out," said Aviela Deitch, a mother of six who lives in Migron. "This is our home and our land and we are staying here."

BIBLICAL TIES

Migron reveals much about Israel's expansion across the West Bank - a territory it seized during the 1967 war and which most Israelis refer to by its old biblical name, Judea and Samaria.

While the United Nations deem all Jewish settlements in the region to be illegal, Israel backs 120 official settlements, home to some 310,000 people. Most of these blocs are expected to be absorbed into Israel in any Palestinian peace accord.

There are also more than 100 outposts built without official authorization that dot the West Bank and are home to almost 2,000 people. Migron is the largest such community.

Supporters of Prime Minister Benjamin Netanyahu want to legalize these, thereby defusing the Supreme Court demolition order and opening the way for possible, rapid expansion.

"We have to find a legal way to support the Jewish communities in Judea and Samaria. We were elected to do this," said Danny Danon, the deputy speaker of the Israeli parliament and a rising star within the pro-settler Likud.

But he faces fierce resistance, at home and abroad.

"This is a clash between settlers, human rights and the rule of law," says Yariv Oppenheimer, the general director of Peace Now, a non-governmental Israeli anti-settlement group that has led the legal fight on Migron.

"If you can't remove Migron, you won't be able to remove any outpost," he said, speaking from his windowless office in the basement of a Tel Aviv apartment block -- a world away from the rocky expanses of the West Bank.

HUMBLE BEGINNINGS

On a clear day from Migron you can see the white stone buildings of Jerusalem, 20 miles to the west. You can also see the Palestinian villages of Burka and Deir Dibwan, where Israel's Supreme Court ruled the owners of Migron's land live.

As happened at many other illegal sites, the military allowed a telecoms antenna to be put up - at Migron that was about a decade ago. Then came barbed wire fences, electricity and caravans.

Settlers built kindergartens and soldiers were dispatched to guard the hill, which overlooks a busy valley road that was the scene of deadly Palestinian shootings during their second so-called Intifada, or uprising, between 2000-2005.

"When we came here in the beginning there was nothing," said Avishai Shitrit, 33, an actor who has lived in Migron with his wife for more than nine years. "You build up your entire life, your dream, build a new community, with the state's help and it feels like your doing the right thing," he said.

Two of Shitrit's children travel to school in a neighboring settlement on a bullet-proof bus. His wife is the local librarian. Like some others in Migron he travels to work in Jerusalem.

Migron attracts religious families who follow strict rules in their daily lives, refusing, for example, to shake hands with members of the opposite sex who are not relatives.

"For 2,000 years we were scattered across the world, persecuted. Finally we have a state, it is our redemption," said Shitrit, bouncing his three-month old daughter on his knee as rain smacked onto the flimsy roof of their home.

"Are we supposed to fight the state?"

Last September Netanyahu's government stunned Migron by demolishing three houses. The pre-dawn raid by border police sparked retaliatory attacks by militant settlers on Palestinian mosques and homes. Settlers also damaged an Israeli army base.

The military is a symbol of national unity and many Israelis viewed the attack on the base as crossing a red line. Migron itself is home to proud army officers and residents say those who attacked the base, so-called 'price taggers', do not come from their ranks.

Police support that view.

"JUST RUGGED GROUND"

The government now suggests Migron residents should stay put for the next two years while a new, legal settlement is built for them around a winery, just down the hill.

But there is no guarantee that the Supreme Court, which was first petitioned over the case in 2006, will accept any further delays. It has yet to make any comment on the proposed compromise, which has not yet been formally presented.

Peace Now says if an official new settlement is created, it would be the first one since the 1993 Oslo Accords, when Israel affirmed the Palestinian right to self-rule in the West Bank.

But no new settlements has not meant no new settlers.

Successive governments have encouraged "natural" growth in established West Bank blocs. That has seen the Jewish population in the area triple over the past 20 years. The Palestinian population has doubled to some 2.5 million over the same period.

Some Israelis were attracted to the region by cheaper housing, some were driven by a pioneering spirit, others by a deep-seated belief that God had given them the land.

All the while, unauthorized communes continued to sprout.

"It was not done in the shadows. All Israeli governments knew it, wanted it and payed for it," said Betzalel Smotrich, a lawyer active in a group which promotes Jewish settlements.

"The governments wanted to set up the outposts on the one hand, but did not want to anger the Americans on the other."

Jacob Perry, a former director of Israel's Shin Bet internal security service and a member of the opposition Kadima party, said the practice had "led to a big, big problem today."

Perry believes the Migron families should be forcibly removed, just as 8,500 Jews were ejected from Gaza in 2005 in a unilateral disengagement that still stirs furious resentment in the settlement camp.

"It can be dealt with. It will cost a lot of effort, but hopefully not a lot of blood," he said. "The majority of Israelis are against illegal settlements. If our leaders take a decision there will be huge support from the Israeli public."

PLAYING POLITICAL INTERFERENCE

Driven in part by religious fervor, the settlers are astute survivors and have joined Netanyahu's Likud party in their droves to influence internal policy making.

"Today, there is no real chance of being elected to the Likud or occupying a significant position in it without swearing allegiance to the positions of the Settlers Council," Makor Rishon daily, which supports Netanyahu, wrote in January.

It is no wonder that some Netanyahu advisors refer to Migron as Migraine.

Treading a delicate path, the prime minister has buried one proposed bill that would have automatically legalized Migron in defiance of the Supreme Court. At the same time, he has appointed a committee to review all illegal outposts.

The committee's findings, though, will arrive after Migron's March deadline passes, meaning Netanyahu must decide who he takes on: the Supreme Court, or the settler wing in his party.

"If the (settlers) win, then the Supreme Court will just be a recommendatory body in the West Bank and the settlers will be able to grab any land they want," said Peace Now's Oppenheimer.

European diplomats in Jerusalem wrote in a recent report that between 2009 and 5 July last year, Israel demolished 1,072 Palestinian structures that they deemed illegal in the West Bank and displaced nearly 2,000 people. These demolitions got a tiny fraction of the media attention devoted to Migron.

The EU report, which was leaked to a handful of media firms, including Reuters, said Jewish settlements combined with the "forced transfer of the native population" were eroding the chances of establishing a viable, contiguous Palestinian state.

Dan Tirza, a map specialist who served on Israeli peace negotiating teams for more than two decades, said that fear was misplaced. "There still is no problem to come up with a map one can live with," he said.

The Palestinians withdrew from U.S.-backed peace talks in 2010, saying Israel must suspend all settlement building as a pre-condition for negotiations. Israel rejects that demand.

Tirza, who has advised Netanyahu, said the best way for the Palestinians to stop the construction was to return to talks.

"Israel has committed time and again that as soon as there is an agreed border, it will remove all the settlers left in the Palestinian territory," Tirza said, "Evacuating the settlements is not the Palestinians' problem, it is Israel's problem."

Sitting in a two-room trailer as their young children played, Shitrit said his Migron friends were united in their determination to stay on top of the hill.

"We're not gladiators here. We don't want destruction, we want to sit down, talk and solve the problem," he said.