Think about it: right now (aside from the ongoing "you slap me, I slap you" games) the Palestinians are basically part of a second-world nation, with various benefits thereof. Decent jobs are available, standard gov't services are provided, basic food & goods & services are available, etc.
BUT...should a separate state be created, can it survive? With practically no farming or industry or ports of its own, with much of the jobs severely reduced by a new real border with real checkpoints & visas, with no gov't services provided or subsidized by its current reluctant supporter, with no apparent motivation on the citizens' parts toward self-sufficiency, and with a total size so small as to be practically impotent in all national/international matters, creating a Palestinian state would regress the Palestinians to a seriously third-world status with no hope or purpose except war.
Perhaps the strategy SHOULD be "give 'em enough rope and they'll hang themselves". As an occupied territory, they'll whine & moan forever. As a soveriegn nation, methinks they'll regress (either on their own or as consequence to attacking Israel) to the natural state of the region: barren wasteland. Maybe Bush is onto something...