Because of the "right of return." That's why they simply don't declare a state based on 1967 borders with Jerusalem as their capital. This is the big issue and it's simply pushed aside because people won't accept that the Arabs are serious about it. When it's listed as #3 not #1 then you know the person doesn't understand it's fundamental importance.
Netanyahu pays hospital visit to family of Palestinian infant killed in arson attack (Haaretz)
from the article: Rabin's son presents his Israeli Peace Initiative