Avi & Philospher,
Making the Palistinians into citizens of Israel with full equal rights is not an option if you wish to keep the state both Democratic and Jewish. There will simply be enough non Jews who will vote away the Jewish character of the state if you did that.
You would have to force all the palistinians to move to Jorden if you would want that to be their state. This would be problematic on both moral and practical grounds.
A two state solution with the Palestinians getting their own state really seems like the only feasible solution.