JERUSALEM (Reuters) -- Israel will stop collecting tax revenues for the Palestinian Authority and not hand over any money if President Mahmoud Abbas continues to seek observer state membership of the United Nations, Israel's finance minister said Saturday.

"If the Palestinians continue to advance their unilateral move they should not expect bilateral cooperation. We will not collect their taxes for them and we will not transfer their tax revenues," Finance Minister Yuval Steinitz said.

On Wednesday, the Western-backed Palestinian Authority circulated a draft resolution to UN member states that calls for upgrading its UN status to that of observer state, despite objections by the United States and Israel.

"It cannot be that they hit us unilaterally and then expect bilateral cooperation with us on economic matters," Steinitz, a close ally of Israeli Prime Minister Benjamin Netanyahu, told a town hall meeting in the southern Israeli city of Beersheba.

Interim peace deals task Israel with collecting taxes and customs duties on the Palestinian Authority's behalf amounting to around $100 million a month, on goods imported into the Palestinian territories.

Israel has previously frozen payments to the Palestinian government during times of heightened security and diplomatic tensions, provoking strong international criticism.

The Palestinians are currently considered an observer "entity" at the United Nations. Upgrading them to a non-member state, similar to the Vatican's UN status, would implicitly recognize Palestinian statehood.

It could also grant them access to bodies such as the International Criminal Court in The Hague, where they could file complaints against Israel.

The status upgrade seems certain to win approval in any vote in the General Assembly, which is composed mostly of post-colonial states historically sympathetic to the Palestinians.

Palestinian diplomats also are courting European countries to further burnish their case.

Debt crisis

Israel and the United States oppose the move, saying Palestinian statehood must be achieved by negotiation. They have called on Abbas to return to peace talks that collapsed in 2010 over Israeli settlement construction in the occupied West Bank.

The Palestinians seek to establish a state in the Israeli-occupied West Bank and the Gaza Strip -- which is controlled by Hamas who -- and want East Jerusalem as its capital.

In July, Israel and the Palestinian Authority agreed on a revamp of revenue collection to try to help relieve the Palestinian government's deepening debt crisis.

The aid-dependent Palestinian economy in the West Bank faces financial crisis due to a drop in aid from Western backers and wealthy Gulf states, as well as Israeli restrictions on trade.