Do you think Israel would even agree on the borders of West Bank and Gaza to give them up? That's the problem now and that would still be the problem with that "solution."
If they weren't idiots, they would. The problem with the Israelis is their proportional election system. They have too many parties, and neither of the big ones is ever able to get a majority alone. That means cutting deals with all the tiny ones, even if they only have a few MPs, and most of the tiny ones are rabid religionists who want a greater Israel. The irony, of course, is most of those they represent do not serve in the IDF, don't work, and don't pay taxes.
But as long as the Palestinians have things like "the right of return" as non-negotiable they'll never agree to something like this anyway.