Terrorism rose to record heights in 1988, as the United States suffered a substantial increase and Israel remained the favorite target, the State Department reported to Congress.

The bombing of a Pan Am jetliner in December over Scotland, which the department's office of counterterrorism said probably was a terrorist incident, and the Palestinian uprising on the West Bank and in Gaza helped push the total of incidents to a new high of 856, up 3 percent from 1987.In all, 658 people were killed and 1,131 wounded, an increase in fatalities from 633 in 1987 but a decrease in injuries from 2,272.

The casualty figures include terrorists themselves who were killed or wounded during attacks as well as attacks by Afghanistan against Pakistan, a U.S. ally that funneled American weapons to Afghan guerrillas.

In all, the citizens and property of 79 nations were attacked in 60 countries. Businessmen and tourists accounted for 77 percent of the victims. The weapon used most often by terrorists was the bomb. It was used in 48 percent of the attacks, said the report released Tuesday.

The Army's top uniformed lawyer contends that the U.S. military can legally attack terrorists without violating a 1976 presidential order that bans assassinations of individuals abroad,

Maj. Gen. Hugh Overholt, the service's judge advocate general, argued in an eight-page draft memorandum that because of changes in "the nature of the threat," action against terrorists can be justified on grounds of national self-defense.

Overholt's memorandum was disclosed Monday by the newsletter Defense Week and confirmed by Army officials.

The State Department report said the United States remained a primary target for international terrorism last year, as the number of anti-U.S. incidents rose from 149 in 1987 to 185. They resulted in 192 persons killed and 40 wounded, compared with seven Americans killed and 47 wounded in 1987.

The increase in deaths was due largely to the attack on U.S.-bound Pan Am flight 103 in which 259 people aboard the jumbo jet and 11 on the ground perished. Of the victims, 189 were Americans.