NEW YORK, Sept 20 (Daniel Bases/Reuters) - Israeli Finance Minister Yuval Steinitz on Tuesday threatened severe financial ramifications if Palestinian President Mahmoud Abbas makes good on a plan to request U.N. membership for a Palestinian state this week.

Steinitz, a close ally of Israeli Prime Minister Benjamin Netanyahu, said his government could stop collecting the 40 percent of the Palestinian Authority's budget through value added, excise and customs taxes.

It is my view, there is no (Israeli) government decision, that if the Palestinians violated the very fundamentals of the peace agreement, we should reconsider delivering tax money to them, Steinitz said in an interview with Reuters.

Taxes that Israel collects on behalf of the Palestinian Authority total about 500 million Israeli shekels ($135 million) a month, Steinitz said.

Steinitz temporarily stopped the transfer of the tax revenues last spring.

The United States and Israel say a Palestinian state should emerge from peace talks between the Palestinians and Israel, which would be impossible if the Palestinians declare a state on their own. Washington has pledged to veto such a Palestinian request at the U.N. Security Council.

If Abbas makes his unilateral declaration, Steinitz said he hoped the attempt would fail, and he questioned whether the PA could run a stable state in which donations and international aid make up 40 percent of the budget.

We are worried because of what we saw in Gaza, he said, referring to the withdrawal of Israeli forces from the territory six years ago, after which the Islamist group Hamas took over within two years.

We are worried because this is a hostile move, he said, adding that Israel wanted a peace based upon a bilateral agreement not a unilateral declaration.

The United States contributes $500 million in financial support annually to the PA. Some U.S. politicians have said they will try to cut American aid to the Palestinians if they refuse to back down.

Palestinian Monetary Authority Governor Jihad al-Wazir told Reuters on Monday that if the United States were to withdraw its aid, it could destabilize the PA.

Really, the risk of a PA collapse is very real under the financial strain, without U.S. assistance, without donor assistance in general, he said.

ABROAD AND HOME

As Jerusalem faces the prospect of a unilateral call for statehood recognition by the PA, its main ally, the United States, tried to convince Turkey to ease diplomatic tensions with Israel.

The relationship soured in 2010 when Israeli soldiers who boarded a Gaza-bound aid convoy trying to run through Israel's naval blockade faced resistance and killed Turkish activists.

From a business perspective, relations are not as bad.

So far there is no impact on the economic cooperation between the two countries, but I hope the overall relations can be fixed again because it is very important for both sides, he said.

Exports to Turkey, which annually are 2-3 percent of its total, were rising in the first half of 2011, Steinitz said.

But no new major defense industry deals have been signed and Israeli tourists have started to avoid Turkey, he said.

Defense, a central part of Israel's psychology, is not being spared in the government's efforts to boost social spending and limit the rising living costs.

Spending on defense is going to be cut, Steinitz said, even when reminded of rising tensions with the PA, Turkey, and the uncertainty in Syria where President Bashar al-Assad has violently tried to smother popular uprisings against his rule.

We have to be very careful, so it will be very modest. But we are going to shift a little bit of money toward more domestic social needs, he said.

Israelis are demonstrating in major protests over the high cost of living. That is in contrast to the last few years where Israel's economy avoided much of the global financial turmoil and unemployment fell to 30-year lows.

On Monday, the government took aim at large business groups with a plan to break them up in bid to boost competition.

Steinitz reiterated he is 100 percent behind the recommendations on the conglomerates.

Israel's economy should grow around 4.8 percent in 2011, Steinitz said, outpacing the original 3.9 percent forecast.

He would not predict 2012 or stray from the official 3.8 percent forecast given Europe's economic problems, chief of which is a sovereign debt crisis. Europe is where 30-35 percent of Israel's exports land.

In a regular situation we would upgrade the forecast for 2012, but because of the developments in Europe, we are not changing it. ($1=3.686 shekels) (Editing by Eric Walsh and Vicki Allen)