Defense Minister Avigdor Lieberman, whose ministry drafted the bill, welcomed the vote in a ministerial committee, the first step toward sending it to parliament to be passed into law.
“Soon there will be an end to this theater of absurd,” he wrote in Hebrew on Twitter, adding that the money confiscated would be used “to prevent terror and compensate victims.”
Israel annually collects around $127 million in customs duties levied on goods destined for Palestinian markets that transit through Israeli ports monthly and then transfers it to the PA.
It has withheld payment in the past, notably in response to Palestinian admission in 2011 to the UN cultural agency UNESCO as a full member.
The Israeli move comes as the US Senate considers a bill approved by the House of Representatives to withhold aid to the PA if it does not stop the controversial practice of so-called martyr payments to families of Palestinians convicted of terrorist attacks.
Republican and Democratic US lawmakers alike have warned that the payments incentivise violence and serve as a sticking point in the Middle East peace process.
According to the Israeli bill, Lieberman will present an annual report detailing payments to “terror activists” and their families granted by the Palestinian Authority,” his office said.
“Based on the report, the sum will be deducted from payments handed from Israel to the Palestinian Authority.”
The bill will now face a series of parliamentary debates and votes before being finalized.
The Palestinian government slammed the move, calling it “piracy and theft” as well as a breach of international law, official news agency WAFA said.
The American legislation, called the Taylor Force Act, is named after a US military veteran and graduate student, age 28, who was killed in a 2016 attack while he was visiting Israel. The attacker, a Palestinian, was killed by police.