For Netanyahu, his inability to build a coalition casts fresh uncertainty over his future as he battles accusations of corruption and likely indictment in three criminal cases.
This failure puts a stop for the time being to his party's efforts at passing legislation that would shield him from prosecution.
And for the White House, the political breakdown presents a significant challenge to the rollout of US President Donald Trump's long-awaited Middle East peace plan.
Jared Kushner, the President's son-in-law and adviser, was scheduled to touch down in the midst of Israel's political maelstrom ahead of talks with Israeli officials about the economic component of the peace proposal.
In national elections in April, Likud won the largest share of the vote and the most seats in Parliament but fell well short of a majority in the 120-seat body. To achieve a majority required balancing the demands of the staunchly secular Liberman and ultra-Orthodox religious parties.
When the prime minister failed to do so, Knesset members, including a stony-faced Netanyahu, decided by a vote of 74 to 45 to dissolve the body just a month after being sworn in, making it the shortest-lived Parliament in Israel's history. The proposed date for new elections is September 17.
"This is devastating to the average Israeli who is really tired of such selfish politics," said Gil Hoffman, chief political correspondent for the Jerusalem Post. "There is no way to explain this situation to the average Israelis who are saying their politicians aren't working for their interests."
Netanyahu and Liberman blamed each other for Israel returning to the polls. Speaking to the Knesset after it voted to dissolve itself, Netanyahu branded Liberman as "part of the left" and said he wanted to topple the government.
"It's completely unbelievable," the Prime Minister said, promising to win in the new elections. "You waste billions, and you paralyse the state for almost a year. We have very important things to do."
While Netanyahu's allies accused Liberman of trying to destroy the Prime Minister, Liberman said there was no "hidden agenda" behind his actions.
Liberman had been insisting on the passage - without amendment - of a bill that sets quotas for drafting the ultra-Orthodox into the military. Ultra-Orthodox parties, which hold 16 seats in Netanyahu's proposed coalition, have asked that the bill's requirements be eased.
Traditionally, the ultra-Orthodox have been exempted from conscription so they can devote themselves to studying religious texts. This exemption is widely resented by many other Israeli Jews, who are required to serve in the military, including many of Liberman's constituents.
A Supreme Court ruling on the issue of ultra-Orthodox conscription has required the government to pass legislation changing the current system of generous exemptions. But some political observers said the legislation itself had little to do with the breakdown of coalition talks.
"The Knesset is dispersing itself over an ego battle," Hoffman said.
Liberman and Netanyahu have a fractious history. Liberman quit Likud in 1997, taking issue with concessions that Netanyahu granted to Palestinians in negotiations leading up to the Wye River Memorandum.
Since then, Liberman has tried to hone a strongman image while repeatedly serving in governments with Netanyahu despite their conflicts. Most recently, Liberman quit his post of Defence Minister last year to protest against Netanyahu's policy in the Gaza Strip, arguing it was too soft on the Hamas militant group that controls the enclave.
Netanyahu accused Liberman of using the current political showdown as a way to win more Knesset seats.
It's possible he could do that, said Maoz Rosenthal, a senior lecturer at the Lauder School of Government at the Interdisciplinary Centre, Herzliya. "This plays perfectly with his base, and this kind of behaviour has benefited him in the past."
Netanyahu had been given a two-week extension beyond the initial deadline to form a government, the maximum time allowed under the law. In the past, when a political leader has been unable to form a coalition, the Israeli president has then given a chance to another Knesset member to do so.
Under the Israeli parliamentary system, the prime minister is not necessarily the leader of the largest bloc in the Knesset but the person able to form a government by lining up a majority of members. In 2009, when Tzipi Livni failed to form a government even though her Kadima Party won the most seats in the elections, it opened the way for Netanyahu to do so and become prime minister.
President Reuven Rivlin said he would "do everything in my power to prevent the State of Israel from going to another election campaign." But while Netanyahu was unable to secure a majority, he made sure no one else would get a chance.
Opposition lawmakers had begun a filibuster aimed at preventing the Knesset from triggering new elections but said they stopped after it became clear that former military chief of staff Benny Gantz of the opposition Blue and White party was also making little headway in his informal efforts to form an alternative coalition.
