The government had controversially approved Shin Bet's use of surveillance as an emergency measure in mid-March as mounting numbers of Israelis tested positive for the Covid-19 illness.
The specifics were kept secret, but security officials said the agency tracked the movements of virus carriers through their phones.
The measure was challenged in Israel's top court, which ruled that the government must get the law changed if it wanted to continue with the policy.
A parliamentary oversight committee on Monday granted the government another 48 hours to start the legislative progress.
But by Wednesday it became apparent the government did not intend to go down that path.
"As of midnight today, it will not be legal to use the Shin Bet to locate phones as part of the battle against the coronavirus," said Zvi Hauser, chairman of the parliamentary foreign and defence committee.
"The fact the government has decided at this point to not go ahead with (such) legislation... proves that our committee's insistence on using alternatives was taken into account," he said in a statement.
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Israeli Prime Minister Benjamin Netanyahu defended his decision to bypass parliament at the time, arguing lives could be lost while lawmakers debated legislation.
Hauser said he hoped that the government would find other solutions, turning to legislation only in case of "a crucial need that cannot be answered by civilian means."
Israel, which has a population of around nine million, announced its first coronavirus patient on February 21.
Since then it has confirmed more than 18,180 cases, including 299 deaths.
Earlier this week, Shin Bet chief Nadav Argaman told members of a ministerial committee he was against his agency being involved in coronavirus tracking, a security official said.
The spy agency's surveillance programme had raised concerns about patient privacy and Israel's adherence to democratic norms.
Tehilla Shwartz Altshuler, from the Israel Democracy Institute think-tank, said falling infection rates had "proven that it is possible to use epidemiological investigations" to tackle the virus.
She called for alternatives which could better ensure privacy, such as the voluntary use of mobile phone apps which have been introduced in other countries.
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