Ahmed Tibi, a prominent Arab legislator, said the comments - some of the most biting Netanyahu has directed at the country's Arab minority - showed the right-wing Likud party leader had "gone off the rails".
Rock-throwing protests have erupted in several Arab communities in Israel since police on Saturday shot dead an Arab man who attacked their vehicle. Police are investigating allegations he was killed after walking away from the officers.
"To all those who are demonstrating and shouting their denunciation of Israel and support of a Palestinian state, I can say one simple thing: you are invited to move there - to the Palestinian Authority or to Gaza," Netanyahu said.
"I can promise you the State of Israel will not put any obstacles in your way," he told a meeting with Likud legislators.
The prime minister went on to promise he will not allow terrorists to succeed in their attempts to "chase us away from every place."
"We will defeat terrorism together. We'll fight the incitement by the Palestinian Authority and act with determination against the rioters that call for the destruction of Israel," he said.
Netanyahu stressed the government will use all means at its disposal, including legislation, to combat the recent wave of terror attacks, "including the destruction of terrorists' homes."
"We need to unite facing this reality. This is not the time for dividing statements. The more united we are, the stronger we are, and this is what is required of the state of Israel today," he said.
Arabs make up about 20 percent of the Jewish state's eight million population.
Talks between Israel and the Palestinians, who seek their own state in the West Bank and Gaza, broke down in April, with the Palestinians angry at the continued building of Jewish settlements in territory they seek for their future state and Israel furious at attmepts to bring the Islamist group Hamas, which officially denies Israel's right to exist, into the Palestinian government.
Tibi accused Netanyahu, who has publicly pledged to explore the possibility of revoking the citizenship of Israelis who "call for Israel's destruction", of pandering to far-right potential challengers in Likud.
The party is to hold a leadership vote in January amid mounting speculation of a national election, due only in 2017, within months.
"These kinds of things have never been said by any prime minister - not by (Menachem) Begin, nor by (Yitzhak) Shamir," Tibi told Reuters, referring to the late nationalist leaders and pre-state underground chiefs.