Deputy Foreign Minister Zeev Elkin suggested Friday that Israel would forgo the money rather than accept a new European Union-mandated caveat that any partnership deals with Israel do not apply to the West Bank, Gaza and east Jerusalem, lands Israel captured in 1967.
The "territorial clause," to be written into future agreements, is part of new EU guidelines and an expression of growing dismay in Europe over continued Israeli settlement expansion.
Israel is particularly concerned about losing access to Horizon 2020, a seven-year, Europe-wide research grant program that starts in 2014 and has an estimated budget of 80 billion euros ($107 billion).
On Thursday, less than a week before Israel-EU talks on Horizon 2020 are to begin, Israeli Prime Minister Benjamin Netanyahu asked for more EU clarifications after consulting with Cabinet colleagues about the potential funding cut. It's not clear how much room there is for compromise.
The EU has insisted that new agreements must be "unequivocal and explicit" in their territorial limitations. At the same time, Europe might want to avoid a showdown with Israel when Israeli-Palestinian peace talks are finally underway following a five-year freeze. Negotiations resumed last month in Washington. Teams are to meet in Jerusalem on Wednesday.
Elkin said Israel is eager to join Horizon 2020, but won't do so under the current terms. "We want to sign and we are ready to negotiate, but if the conditions are as they are today, which are unprecedented, ... we can't sign," Elkin told Israel Radio.
The Palestinians welcomed Europe's stance.
"For the first time, Israel finds itself face to face with a minimum level of accountability," said Hanan Ashrawi, a senior PLO official. "I would say it's been a long time in the making. We have been discussing this for more than 20 years with the Europeans."
In Israel, a nation proud of its thriving high-tech and research sector, the threat of losing vital EU funding has shifted the domestic debate on settlements.
Traditionally, opponents have argued that the dozens of settlements Israel has built since 1967 in the West Bank and east Jerusalem are an obstacle to peace and divert money from Israel's poor. Some critics warned Friday that a pro-settlement policy could hurt Israel's innovative edge.
The confrontation with the EU "reveals the price of the continued normalization of construction in the settlements," Israeli columnist Nahum Barnea wrote in the Yediot Ahronot daily. "It is not just `settlements instead of (disadvantaged) neighborhoods.' It is settlements instead of research, instead of high-tech, instead of industry."
Israel did well under Europe's research grant program FP7, which ran from 2007-2013 with a budget of 55 billion euros ($73 billion). Israel paid 535 million euros ($714 million) into the fund and received 634 million euros ($846 million) in grants. It was Israel's second-largest source of research funding in recent years.
Under Horizon 2020, Israel likely would contribute about 600 million euros ($800 million), but could expect a payout of more than 1 billion euros ($1.33 billion), according to Israel's Science Ministry.
The loss of the funding worries scientists.
"I can't image that there will be a time that we won't get funding from the EU," said Yoram Reich, a professor of mechanical engineering at Tel Aviv University who receives European funding. "It's almost the death penalty for many people."
Isaiah Arkin, vice president for research at the Hebrew University of Jerusalem, argues that Europe benefits from Israeli participation as much as the other way around. He said that "there is nothing to be gained by assigning political preconditions that would prevent us from being successful together in the future."
Under the new guidelines, funded research must be conducted entirely in Israel's pre-1967 lines. For loans, also offered by Horizon 2020, rules are even stricter; companies doing any business in the occupied lands, even if that activity is not linked to EU funding, are not eligible.
Israel would not be able to sign off on Europe's terms on legal grounds, particularly when it comes to east Jerusalem, annexed by Israel after the 1967 war, said an Israeli government official who spoke on condition of anonymity because he was not permitted to discuss internal deliberations with the media. With Israel considering east Jerusalem as part of its territory, it would violate its own anti-boycott regulations if it accepts the EU rules, the official said.
The annexation was not recognized by most countries in the world, and the Palestinians want east Jerusalem as the capital of their state.
The EU has said it will recognize any changes to Israel's border that come as a result of negotiations with the Palestinians. Netanyahu has said he's willing to cede land to a Palestinian state, but has refused to recognize the 1967 lines as a starting point or consider a partition of Jerusalem.
Alon Liel, a dovish former Israeli diplomat, said Europe is helping prod Israel toward a moment of truth.
"Israel needs to understand that if it is really going for an agreement (with the Palestinians), it needs to make a dramatic, drastic change in its attitude toward the territories," he said. "And that is what Europe is demanding."