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The e-Communities initiative was designed to help 100 deprived urban and rural communities across Wales establish public IT centres, but the assembly canned the scheme after it failed to launch a single project in the two years since it was set up.
Welsh Nationalists in the assembly condemned the scrapping of the scheme. They were particularly concerned because it was a major element in the Welsh Assembly's Online Wales strategy.
Plaid Cymru Euro MP Jill Evans said the project had been axed, at the expense of communities that needed help, because the Labour-led assembly government was "hard-pressed" to find the matching funding needed to get EC investment.
A Welsh Assembly spokesman said, "There have been a number of concerns about the effectiveness of the e-Communities programme."
He said the £16.5m would now be allocated to other projects related to innovation and technology, including a scheme under which poor communities will be able to appeal directly for funds to finance their own IT projects, instead of having them financed through a single large project.
The spokesman rejected Plaid Cymru's claim about a lack of matching funding being the main reason for the axe, and described it as "mischief-making".