Israeli officials have confirmed reports that Prime Minister Ariel Sharon is looking at a redrawing of Israel's borders.
Mr Sharon said the pullout from Gaza was 'painful' but vital
He has proposed handing over Arab Israeli towns to the Palestinians in exchange for parts of the West Bank.
Mr Sharon has also gained the backing of the main opposition Labour Party for his proposals to evacuate 17 Jewish settlements in the Gaza Strip.
That plan was welcomed as good news by Palestinian Prime Minister Ahmed Qurei.
Mr Qurei said he hoped Israel would withdraw from all Palestinian areas in order to bring about a real peace.
Under Mr Sharon's proposed land swap, some of Israel's Arab population would be put under Palestinian control.
"I asked that it be examined legally. It is a complicated
problem. I don't have an answer on the matter yet, but I am certainly checking it," Mr Sharon told Maariv newspaper.
Officials stressed that such a deal would only happen with approval from Israeli Arabs and under a final peace deal with the Palestinians.
Israeli Arabs make up about 20% of the population and live mainly in the north of the country.
Mr Sharon won a no-confidence vote in parliament on Monday by a single vote after his announcement on the evacuation of the Gaza settlements.
On Tuesday, Israel's main opposition Labour Party backed the plan.
Labour leader Shimon Peres - who on Tuesday was elected head of his party for another two years - congratulated Mr Sharon on the move.
He said the Gaza plan paid tribute to the assassinated Labour Prime Minister, Yitzhak Rabin, who had favoured a land for peace deal with the Palestinians.
"If Sharon carries out his proposal I promise him our full support in the Knesset, whatever happens along the way," said the former premier.
Mr Sharon had earlier been criticised over the plan by pro-settler parties within his coalition.
One cabinet minister, Effi Eitam, from the National Religious Party, described the plan as the beginning of the end of the government.
But Mr Sharon said he would not hesitate to set up another government if right-wing coalition partners withdrew support.
The prime minister, who had previously been seen as a champion of the settlers, said his Gaza plan was a "painful" one, but vital for the future of Israel.
He has said he will be seeking approval and possible financial assistance from the United States.
Observers say Mr Sharon is hoping to visit US President George W Bush later this month and Monday's surprise announcement may have been timed to boost chances of a meeting.
Mr Sharon's plan would involve relocating more than 7,000 Jewish settlers from 17 settlements in Gaza to Israel, and from another three settlements in the West Bank.
"I am working on the assumption that in the future there will be no Jews in Gaza," he said in an interview with Haaretz newspaper, published on Tuesday.
He told the newspaper the process would take one to two years.
Settlers' leaders have vowed to use all legal means to fight Mr Sharon's proposals.