Livni has been trying to cobble together a government since she was elected head of the ruling Kadima Party, replacing corruption-tainted Prime Minister Ehud Olmert, in September. But partners in the current coalition, which took power in May 2006, used the changing of the guard to press new demands.
In a statement Sunday, Livni said she was willing to make concessions but had to draw the line at "impossible" demands.
"When it became clear that everyone and every party was exploiting the opportunity to make demands that were economically and diplomatically illegitimate, I decided to call off (talks) and go to elections," she said.
Livni had been scheduled to formally convey her decision to President Shimon Peres in the early afternoon. But she postponed that meeting after parliament speaker Dalia Itzik embarked upon a last-ditch bid to salvage coalition talks.
If that effort fails, elections for Israel's 120-seat parliament, scheduled for November 2010, are likely to be moved up to February or March, political commentators have said. In his ceremonial role, Peres makes the final decision on whether and when to hold elections.
Early elections had appeared likely since Friday, when the ultra-Orthodox Shas Party announced it would not join a Livni-led government.
Livni resisted Shas' demands that she refuse to negotiate a power-sharing arrangement with the Palestinians for Jerusalem, whose eastern sector the Palestinians claim as capital of their hoped-for state. She also refused to promise Shas the hundreds of millions of dollars it demanded for social welfare and its religious seminaries, aides said.
Shas has been a key member of the outgoing coalition, and without the party's support, it would be difficult for Livni to maintain a parliamentary majority.
Peres could ask another politician to try to form a government, but as leader of the largest party in parliament, Livni is the only candidate with a realistic chance of forming a coalition.
She could have ruled with a narrow parliamentary majority, but such a government would have difficulty shepherding through a peace accord with the Palestinians that would require painful Israeli concessions. Israel is also holding indirect peace talks with Syria after an eight-year freeze.
Livni has been serving as Israel's chief peace negotiator with the Palestinians since talks were formally relaunched last November at a U.S.-hosted summit. The sides had hoped to reach a final peace accord by the end of the year, though both Olmert and Palestinian President Mahmoud Abbas now call that target unrealistic.
An aide to Abbas warned the Israeli political turmoil could threaten peacemaking.
"Time is precious. The next few months will be wasted because of new elections and the U.S. elections," Nabil Abu Rdeneh said.
Before Livni's coalition-building efforts faltered, opinion polls had given her and Netanyahu even odds on taking power. Some voters might be impressed by her tough stand against Shas, or by any breakthroughs in negotiations that might emerge before the balloting.
A cease-fire that has nearly ended rocket barrages on Israel from the Gaza Strip since June could also play in her favor if the truce is extended beyond its December deadline.
But any resumption of the attacks from Gaza could hurt Livni.
And her failure to muster a government could hurt her political standing.
Peacemaking foundered during Netanyahu's 3-year tenure as prime minister in the 1990s, and his positions have not softened since.
He quit Ariel Sharon's government because he opposed Israel's 2005 withdrawal from the Gaza Strip and opposes ceding sovereignty over any part of east Jerusalem, which Israel captured in the 1967 Mideast war.
Palestinians claim east Jerusalem as capital of their hoped-for state and insist on shared sovereignty over the city.
The move to elections could propel Abbas and Olmert to redouble their efforts to achieve a peacemaking breakthrough.
Last month, Olmert said Israel would have to give up nearly all of the West Bank and east Jerusalem if it wants peace with the Palestinians. He also said Israel would have to relinquish the Golan Heights, likewise captured in 1967, to obtain peace with Syria.
A meeting between Olmert and Abbas, which had been scheduled for Monday, was postponed until further notice because of the Israeli political upheaval, Abu Rdeneh said.
Peacemaking has been further hobbled by the dueling Palestinian governments in the West Bank, which Abbas rules, and the Gaza Strip, controlled by the Islamic militant Hamas since a violent June 2007 takeover.
On Sunday, Hamas called on Palestinians to resume talks on healing their political rift.
"The call for early elections and Livni's failure to form a coalition government in Israel is a slap in the face to those who still dream of negotiations," Hamas spokesman Sami Abu Zuhri said from Gaza City.