Jerusalem being the undivided capital of Israel doesn't mean the palestinians can't have a state in the west bank. They'll just have to make due with Ramallah or (if they're smart, which they're not) Hebron. 

The large majority of the population of west bank Israeli towns and cities are within the security barrier, which was (in some reports) planned by Arik Sharon to be the new eastern border. The Jewish inhabitants beyond can be evacuated as they were in Gaza and Sinai. 

In 2000, many Israelis would have divided Jerusalem. However, Arafat's rejection of the peace deal offered (Bill Clinton blamed Arafat for the peace talks' failure) the palestinians subsequent behavior, and subsequent rejection of a peace deal in 2008, has closed that door). 

Given the palestinians notable aversion to any and every two state solution - its ridiculous to keep Jerusalem open to re-division as an enticement to peace.