The cabinet also approved a bill to submit any peace treaty with the Palestinians to a referendum, largely seen as an effort to appease an overwhelming right wing coalition wary of concessions that Israel could be demanded to make during the talks to be held in Washington on Tuesday or Wednesday.
"Any agreement which may be reached in negotiations will be put to a referendum," the Prime Minister's office said in a statement. "It is important that on such historic decisions every citizen should vote directly on an issue deciding the country's future."
After nearly six-hour meeting, the 22-member cabinet approved Netanyahu's proposal by 13 votes to seven with two abstentions. Under this 104 long-serving Palestinian and Israeli Arab prisoners will be released in 4 stages over 9 months.
The cabinet also voted for the bill to bring peace deal to national referendum.
The peace talks were stalled since September 2010 over Isarel's policy of settlement in the occupied land.
Earlier, a cabinet briefing paper said the government saw the referendum bill as "urgent and important" and said it would be asking parliament to fast-track its passage into law.
Sources said that the referendum bill could be brought to the Knesset for a first reading as early as this week.
A referendum, if passed, would be a final endorsement of a treaty after ratification by the government and parliament.
Many lawmakers from Netanyahu's ruling Likud party as well as coalition partners have been vociferously opposing major concessions to the Palestinians, including proposed good will gesture of releasing Palestinian prisoners.