Kadima leader Shaul Mofaz brought the party into the coalition to work with Netanyahu on ending a contentious, decades-old system that has granted draft exemptions to tens of thousands of ultra-Orthodox Jewish seminary students. But with a court-ordered Aug. 1 deadline to revise the law, the sides were unable to forge a compromise.
"We made a real effort to push toward a new law that would change the balance of service," Mofaz, a former military chief of staff, told a news conference.
Mofaz said he tried to forge a "new social contract," but was presented with "red lines" that couldn't be crossed. "We are going back with our heads held high to lead the nation in the opposition," he declared.
Kadima is the largest party in Israel's parliament, winning one more seat than Netanyahu's Likud Party in the last election, but it was left outside the government when Netanyahu set up his original hard-line team three years ago.
The draft exemptions have caused widespread resentment among Israel's secular majority, who are required to perform two to three years of compulsory service. Ultra-Orthodox leaders have been equally adamant in their refusal to compromise, claiming their young men serve the nation through prayer and study.
Netanyahu had sought a system that would gradually draft growing numbers of ultra-Orthodox over several years, and continue the exemptions for a smaller number of them. Mofaz wanted fewer exemptions and for the ultra-religious to be incorporated much faster. The talks were been complicated by calls for Israel's Arab minority, who are exempt from the draft, to be forced into civilian national service.
In a letter to Mofaz, Netanyahu expressed regret over Mofaz's decision.
"I am sorry that you decided to give up the opportunity to bring about a historic change. After 64 years we were very close to a significant change in spreading the burden (of army service)," he said. "I will continue to work to bring a responsible solution that Israeli society expects."
It remained unclear what would happen after Aug. 1. Defense Minister Ehud Barak said on that date he would begin drafting an unspecified number of ultra-religious soldiers and propose temporary legislation until a more permanent arrangement can be made in the coming months.
Netanyahu's government, torn between religious and secular parties, was on the brink of collapse over the draft issue when Mofaz was lured into the government in an overnight deal in May. Those divisions are likely to hinder new attempts by Netanyahu to reform the draft.
Kadima's addition gave Netanyahu a majority of 94 seats in the 120-member parliament, raising hopes that they would not only resolve the draft issue but also make progress on peace matters with the Palestinians.
Mofaz, a political moderate, favors broad concessions to the Palestinians and has proposed formation of an interim Palestinian state while final borders are negotiated.
With Mofaz's departure, Netanyahu appears unlikely to float any bold proposals toward the Palestinians. During a visit this week by U.S. Secretary of State Hillary Rodham Clinton, the Palestinian issue barely factored in discussions.
Palestinian government spokesman Ghassan Khatib refused to comment, calling the resignation an internal Israeli matter.
Mofaz came under heavy criticism from political moderates when he joined Netanyahu last May. His sudden change of mind Tuesday was certain to raise further doubts about his leadership skills, and could hurt Kadima's political prospects down the road. Opinion polls have predicted the party would plunge to roughly 10 seats, about one-third its current level, if new elections were held.
"Political cooperation born in sin was destined to end," said former Kadima leader Tzipi Livni.
Livni might now try to take another run at the Kadima leadership. Analysts have also speculated that former Prime Minister Ehud Olmert, cleared in a high-profile corruption case last week, might also try to jump back into politics. Olmert confidants say he will not make any decision until he resolves another pending corruption case.
Yaron Ezrahi, a political science professor from Hebrew University, said Netanyahu would weather the storm.
He noted that peace efforts with the Palestinians have been stalled during Netanyahu's three-year tenure in any case, and there was little momentum to revive them.
"Who is talking about the peace process today?" said Ezrahi. "The peace process is paralyzed by the two leaderships, and not by the peoples, who are tired of war and craving peace."
Instead, Netanyahu will remain focused on working with the U.S. on preventing Iran from developing nuclear weapons an issue for which he has broad public support.