US President Donald Trump has threatened to halt aid to the Palestinians if they do not agree to take part in peace talks.
The state department confirmed he was talking about aid for economic and security assistance.
Mr Trump accused the Palestinians of "disrespecting" the US, and said: "Why should we do something for them when they do nothing for us?"
The Palestinians have rejected the US as a neutral broker in peace talks.
They are furious at Washington's controversial decision in December to recognise Jerusalem as the capital of Israel.
Former Palestinian negotiator Saeb Erekat said of the US president's latest comments: "Trump could buy many things with his money, but he won't be able to buy the dignity of our nation."
Why the focus on Palestinian aid?
Speaking at the World Economic Forum in Davos in Switzerland, Mr Trump said the US gives the Palestinians "hundreds of millions of dollars in aid and support" a year.
He chastised the Palestinian leadership for "disrespecting… our great Vice-President" Mike Pence by refusing to meet with him in the region earlier in the week.
And he said he was the first US president to link the issue of aid funding to the peace process.
"That money is on the table and it's not going to them unless they sit down and negotiate peace," he said, sitting beside Israeli Prime Minister Benjamin Netanyahu.
"I can tell you that Israel does want to make peace and they're [the Palestinians] going to have to want to make peace too or we're going to have nothing to do with it any longer."
But the US state department later confirmed this was not the aid Mr Trump was referring too. He was instead talking about bilateral funding for economic support and some security training.
US bilateral aid to the Palestinians amounted to $260m in 2016. By contrast, Israel receives more than $3bn in military aid per year from the US.
What about the peace process?
The US president said his administration had a "proposal for peace" that was "a great proposal for the Palestinians" and suggested Israel was prepared to make some concessions.
"You won one point," he said to Mr Netanyahu, referring to Jerusalem, "and you'll give up some points later on in the negotiation, if it ever takes place."
But he added: "I don't know that they [peace talks] will ever take place."
The last round of on-off peace talks between the two sides collapsed amid acrimony in April 2014.
What did Trump say about Jerusalem?
Mr Trump stood by his decision to recognise Jerusalem as Israel's capital – a move that broke with decades of a US policy of neutrality on the issue and put it out of step with the rest of the international community.
He told Mr Netanyahu: "Israel has always supported the United States so what I did with Jerusalem was my honour."
And he reiterated his view that by taking "Jerusalem off the [negotiating] table… we don't have to talk about it any more" – suggesting it could move forward the peace process.
"They [the Palestinians] never got past Jerusalem," he said.
The status of Jerusalem goes to the heart of the Israeli-Palestinian conflict.
Israel regards Jerusalem as its "eternal and undivided" capital, while the Palestinians claim East Jerusalem – occupied by Israel in the 1967 Middle East war – as the capital of a future state.
What do the Palestinians say?
At a meeting of the UN in New York, soon after Mr Trump had spoken, Palestinian ambassador Riyad Mansour said the decision to reject Washington's recognition of Jerusalem as Israel's capital was not intended as "disrespect" but rather a "position rooted in full respect for the law, for the principles of justice and equity".
"The holy city is in the hearts of each and every Palestinian, Arab, Christian and Muslim, and there will be no peace without East Jerusalem being the sovereign capital of the State of Palestine," he added.
What does Israel say?
Prime Minister Netanyahu was effusive in his praise of Mr Trump over his decision to recognise Jerusalem as Israel's capital.
"By recognising history, you've made history, and we will always remember that," he told the US president.
He later told a meeting at Davos that "under any peace agreement the capital of Israel will continue to be in Jerusalem".
He also said that "the Palestinians should have all the power to govern themselves but none of the power to threaten us".
"In any political arrangement the Jews must retain security control in the area, because otherwise you'll have [the Islamic State group] … We have a mosaic of failed states in the Middle East, and we don't want another one," he continued.