I would be all in for discuising small races as Goblins ...
But im not quite sure about the dialogues ... for one, it could end up as another layer of development hell for Larian ... and for two, it sounds like lot of work, concidering only part (those who use the spell) of part (those who play small race), will be able to see it. :-/
Honestly, personaly i would be quite cool with them ignoring my goblin as long as i dont talk to them ... and if i do, simply say something like "never seen ya before" ... and continue with generic conversation.
I still dont understand why cant we change Race for our hirelings.

Lets us play Githyanki as racist as they trully are!