RAMALLAH, Jan 9 (Ali Sawafta/Reuters) - The Palestinian Authority will have to raise income tax and cut costs in 2012 to counter lower-than-expected foreign aid donations, Prime Minister Salam Fayyad has said.

The authority's growing financial difficulties coincide with a period of high political uncertainty for the Palestinians, with long-running attempts to end a feud between rival factions in the West Bank and Gaza floundering.

The Western-backed Fayyad had promised to stand down to help reconcile the two Palestinian territories. But with no agreement in sight, he has drawn up 2012 budget plans and warned that sacrifices will be needed to bolster already battered accounts.

We have prepared a package of measures aimed at reducing the deficit ... and reduce the likelihood of the crisis continuing in 2012, he said late on Sunday.

Fayyad said income tax rates for high earners would have to double to 30 percent from 15 percent, while more entities would have to pay tax on their operations.

Government spending would also be cut and some of the PA's 153,000 public sector workers might be forced into early retirement.

The Palestinian Workers Union immediately threatened to fight such measures.

After running up a $350-million-deficit in 2010, the PA - which exercises limited self-rule in the Israeli-occupied West Bank - plunged $1.1 billion into the red in 2011. Fayyad said his plan would reduce the 2012 deficit to $750 million.

The Palestinians had planned for foreign aid of about $1 billion in 2011, but Fayyad said just under $750 million had arrived. Financial support from the United States, the European Union and Arab states allows the PA to pay the salaries of the public workers, including teachers and security forces.

However, the United States abruptly cut off funding last year after Palestinian President Mahmoud Abbas went against the will of both Washington and Israel by demanding recognition of Palestinian statehood at the United Nations.

Officials say more than $150 million of U.S. aid is frozen.

The U.N. statehood bid has ground to a halt, with the Palestinians failing to get enough backing to secure a vote in the Security Council.

Unexpectedly, after a break of 15 months, Palestinian negotiators met their Israeli counterparts face-to-face in Jordan last week to resume initial contacts over peace talks.

The Palestinians had previously demanded a halt to Jewish settlement building in the West Bank before holding more talks.

The Israelis have refused to accept this pre-condition and some Palestinians have openly questioned whether their leadership has agreed to return to the negotiating table in return for international assurances of economic support.

PA officials have denied any such link.

Fayyad said his government owed private sector contractors, including medical suppliers, about $400 million. It also owed $1.1 billion to local banks, and could not borrow any more, he said.

In a report issued last September, the World Bank said progress made by the Palestinians in building institutions for statehood could be undermined by their budget crisis.

It said the PA had made substantial progress towards implementing the objectives of a two-year plan to prepare for full independence, but said the growing cash shortage could jeopardize its efforts.

Fayyad, appointed by Abbas in 2007, is credited with revitalizing the economy. But the Islamist group Hamas, which controls Gaza, accuses him of helping Israel to blockade their coastal territory and have never recognized him. (Writing by Jihan Abdalla; editing by Crispian Balmer and David Stamp)