Thousands gathered in the Palestinian territories to mark the "Nakba"
Palestinian Authority President Mahmoud Abbas says he is determined to end Israel's occupation of Palestinian land, labelling it "mankind's shame".
Mr Abbas also said his hands were extended in peace, as Palestinians mark the "catastrophe" of Israel's creation.
More than 700,000 Palestinians were displaced in the war that followed Israel's establishment in 1948.
US President George W Bush, who is visiting the country, told MPs that Washington was Israel's closest ally.
As Palestinians recalled the "Nakba" (catastrophe) 60 years ago, Mr Abbas said in a televised speech: "It is time for this occupation to leave our land and blood.
"It is time this mankind's shame, which is called the Palestinian people's Nakba, to end."
Sirens sounded across the Palestinian territories during two minutes of silence for those who fled or were expelled in the conflict that followed Israel's declaration of independence.
Protest rallies were held across the West Bank and Gaza, and demonstrators released 21,915 black balloons - one for each day since Israel's creation.
Many Palestinians accuse Israel of collective punishment in its attempts to quash Palestinian militants, says the BBC's Katya Adler in Jerusalem.
MPs walk out
At the Erez border crossing in Gaza, Israeli troops opened fire towards demonstrators.
There was no immediate word of any casualties. There were also clashes between Palestinian protesters and Israeli troops near the Qalandiya refugee camp in the West Bank.
Palestinians' black balloons on 'Nakba' day
In Jerusalem, Mr Bush received a standing ovation from MPs at the Israeli parliament, the Knesset.
Mr Bush said: "Israel's population may be just over seven million.
"But when you confront terror and evil, you are 307m strong, because the United States of America stands with you."
The president did not repeat his ambition, stated earlier this year, for a full peace deal between the Israelis and Palestinians within the next eight months.
He again urged action to prevent Iran obtaining nuclear weapons.
"Permitting the world's leading sponsor of terror to possess the world's deadliest weapon would be an unforgivable betrayal of future generations," he said.
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There is only one solution - the right to return to the occupied land
And he backed Israel's refusal to negotiate with the Islamist Hamas movement, saying it should never be forced to deal with "killers pledged to its destruction".
Israeli PM Ehud Olmert said there should be a different Middle East over the next 60 years that would include a democratic homeland for Palestinians.
He also said he thought the Israeli people and parliament would overwhelmingly back a peace agreement with the Palestinians.
A number of hardline Israeli MPs walked out as he spoke.
Mr Bush's Middle East visit will include Saudi Arabia and Egypt.
But there will be no trilateral summit between the American, Israeli and Palestinian leaders and Mr Bush will not visit the Palestinian territories.
Instead, he is to meet Mr Abbas in Egypt.