They are being designated as national priority zones, meaning they will qualify for grants, tax benefits, and other forms of aid.
The move comes amid anger by Jewish settlers at a government-imposed curb on new building in settlements.
The Labour Party leader warned some of the new money might go to extremists.
On Friday a mosque in the West Bank was set on fire, and sprayed with Hebrew graffiti.
Labour leader Ehud Barak said: "I don't think that we need to award them a prize in the form of including them in the national priority map."
His five ministers in the coalition government voted against the plan. The other three right-wing parties in the coalition - Likud, Yisrael Beiteinu and Shas - voted for it.
Arabs to benefit
The national priority zones plan is designed to funnel money into deprived areas. About two million Israelis live in those areas - approximately 110,000 of them in West Bank settlements.
The international community considers all settlements in Israeli-occupied Palestinian land as illegal under international law, though Israel disputes this.
A senior government official said far more Israeli Arabs than Jewish settlements - eight times as many - would benefit from the programme.
But opposition parties denounced the inclusion of settlements, saying it proved the government was not committed to a peace process with the Palestinians.
The Kadima Party said it "cancelled out any declaration made by [Prime Minister Benjamin] Netanyahu regarding two states for two peoples".
The left-wing Meretz faction submitted a motion of no-confidence in response to the plan.
But Mr Netanyahu denied the change had any implications for the peace process.
"We will determine the future of settlements only within the framework of a permanent agreement [with Palestinians]," he said.
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