The draft, sponsored by Qatar on behalf of other Arab nations, accused Israel of a "disproportionate use of force" that endangered Palestinian civilians, and demanded Israel withdraw its troops from Gaza.
The United States was alone in voting against the resolution. Ten of the 15 Security Council nations voted in favor, while Britain, Denmark, Peru and Slovakia abstained.
The U.S. has periodically used its veto to block resolutions critical of Israel. The last council veto, in October 2004, was cast when the United States blocked a resolution condemning another Israeli operation in Gaza.
The draft was reworked repeatedly to address concerns that it was too biased against Israel. Language was added calling for the release of an abducted soldier and urging the Palestinians to stop firing rockets at Israel.
Nonetheless, U.S. Ambassador John Bolton said it was still unacceptable because it had been overtaken by events in the region including the capture of two Israeli soldiers by Hezbollah militants on Wednesday and was "unbalanced."
"It placed demands on one side in the Middle East conflict but not the other," Bolton said. "This draft resolution would have exacerbated tensions in the region."
The resolution called on Israel and the Palestinians to "take immediate steps to create the necessary condition for the resumption of negotiation and restarting the peace process." It urged all parties to help alleviate the "dire humanitarian situation" faced by Palestinians.
The United States sought a text that said the Israeli actions were in direct response to rocket attacks against Israel and Shalit's capture.
Bolton said the United States remains "gravely concerned" at the escalation of the conflict and believes the best way to calm the situation is for Hamas to release Shalit.
The draft also demanded Israel release the Palestinian officials it has arrested.
The Palestinian observer to the U.N., Riyad Mansour, said he was disappointed with the council's "continued inability to act while innocent Palestinian civilians continue to be brutally killed by the Israeli occupying forces."
Referring to past U.S. practice of vetoing similar resolutions, Mansour said the council is failing the Palestinians. In Gaza, the Palestinian Foreign Ministry spokesman, Taher al-Nunu, said the United States must bear some responsibility for Israel's attacks.
"The veto is a political cover for the crimes of the occupation, and regrettably, instead of putting war criminals of this government that lost its mind on trial, they are giving a political cover to carry out more of these crimes," al-Nunu said.
In a speech to the council immediately following Mansour, Israel's U.N. Ambassador Dan Gillerman thanked the U.S. for its "bold stand." He defended Israel's actions and put the blame for attacks against Israel squarely on Iran and Syria.
"What we are seeing are the actions of Hamas and Hezbollah, but they are merely the fingers of the bloodstained hands and the executioners of the twisted minds of the leaders of the world's most ominous axis of terror, Syria and Iran," he said.
Eight of the last nine vetoes in the council have been cast by the United States. Of those, seven concerned the Israel-Palestinian conflict.