The Muslims will always use the territory as a forward base to launch attacks at Israel. They will hide among the locals and strike with missiles and mortars. They will continue overnight raids into Israel to harrass and murder Jews.
If Israel is to survive, I see no alternative but to occupy Gaza and clean it out house-by-house. Borders and ports must be controlled for smuggled weapons and terrorists. And the populace must be policed to maintain this.
On paper, we want land for peace. But Arafat rejected that in 2000. So that's the end of that.
Technically, the second state is Jordan. Jordan was part of the British mandate of Palestine.