I recite a C. Fox Smythe poem that also contains the term "dago" and I substitute the word Spanish for it. I think we need to recognize that there is no dividing line for ethnic slurs. If the "N-word" is a perjorative against blacks then the "D-word" is one against Hispanics. I need to ask my brother in law about this. He is a Mexican National and would have a good opinion.The other side of the coin is that the old timers didn't neccessarily mean anything derogatory when they used these terms. It was the way to distinguish between people. Of course, there were plenty of people even then who used the words intending to hurt. We can't get around that. Humans are human.
If you are going to use "dago" in a song to be historically accurate then you should be willing to use the other terms as well and stand ready to take the flak. It all boils down to knowing your audience and what they will stand for.
There are those who mourn such cleansing of the old songs and ask where it will end. I understand and believe in their position but also recognize that improving relations between the races will take generations. Erasing these things from the old songs is a small step on that path and a small sacrifice in the overall picture.