Well this all sounds well in principle - except that those Palestinians living in the West Bank etc. are governed by people who would never recognize Israel as a state. So the 2-state resolution doesn't just rest with Israel.  

I've been to Israel. It is a tiny country, you can  probably circumvent it in a car in a day.  It's population density is very high, with the Arab and Orthodox Jewish populations reproducing at a very high rate and contributing relatively little to the economy. Surrounded by hostile nations, it's got a whole host of problems besides resolving the 2-state issue.