I don't think companies should take a stance on political issues, which is what Google is doing here. Would actually prefer companies have totally no influence on politics at all, but as we all know, that would be an utopia.
You do realise that however they refer to the region ('Palestine' or 'Palestinian Territories'), they're making a political statement. Their reasoning (following the example of multiple international organisations - including the UN, ICANN, and ISO) is sound.
Imagine making a desktop environment and e.g. showing a world map to select your time zone.
Or having a list of countries & regions to assist the user with localization. Seemingly any list of countries you show will "make a political statement" to someone out there. KDE, for example, had many bugs filed about the naming used for what the ISO calls the Former Yugoslav Republic of Macedonia.
http://en.wikipedia.org/wiki/Macedonia_naming_dispute
http://www.iso.org/iso/home/standards/country_codes/country_...