Ziad Abu Ein, 55, a minister without portfolio, was taking part in a protest against Israeli settlements when he was involved in clashes with around 30 Israeli troops and border police, a Reuters witness said.
Abu Ein was confronted by a border policemen who grasped him by the neck and briefly held him with one hand. Minutes later the minister began to look faint and fell to the ground clasping his chest. He died on his way to hospital.
It was not clear what caused his death.
Palestinian President Mahmoud Abbas described the attack as "a barbaric act which we cannot be silent about or accept". Abbas announced three days of national mourning and said he would take "necessary steps" after an investigation.
The Israeli army said it was looking into the incident. Prime Minister Benjamin Netanyahu's Arabic language spokesman said the circumstances leading to the death of the minister were being investigated.
The incident comes at a time of heightened tension between Israel and the Palestinians, following months of violent unrest in Jerusalem, Tel Aviv and the Israeli-occupied West Bank.
Ten Israelis and a foreign visitor have been killed by Palestinian assailants over the past three months, while more than a dozen Palestinians have also been killed, including most of those who carried out the attacks.
Abu Ein, who was convicted of killing two young Israelis in a bomb attack in 1979 and released as part of a prisoner swap in 1985, was a vocal opponent of Israel's settlement building in the West Bank, which Palestinians want as part of an independent state together with Gaza and East Jerusalem.
On Wednesday, he and around 100 foreign and Palestinian activists were on their way to plant trees near a Jewish settlement as part of a regular protest by a group called the Committee to Resist Settlements and the Wall.
Shortly before his death, Abu Ein spoke to television reporters, sounding hoarse and short of breath.
"This is the terrorism of the occupation, this is a terrorist army, practising its terrorism on the Palestinian people," he told the official Palestine TV. "We came to plant trees on Palestinian land, and they launch into an attack on us from the first moment. Nobody threw a single stone."
Palestinians in Ramallah closed shops in protest at the minister's death and youths threw stones at Israeli soldiers guarding a Jewish settlement outside the city, Palestinian security sources said.
Palestinian officials indicated that cooperation between Palestinian and Israeli security forces in the West Bank could be suspended as a result of Abu Ein's death.
