As others have pointed out, yes this idea works. For those concerned about breaking the paper bags. This is not a problem. The concrete will set up way before the bags even begin to rot.
As far as actually building the wall, I don't think you can build a perfectly vertical wall this way. I think each course needs to be stepped back from the previous one. Which means that you will need to back fill, (and tamp), as you go. At the very least you will want to do a running bond with the bags. You can allow the ends of the wall to taper in as you go up. The other option would be to use a flemish bond where every other bag is turned 90 degrees so the narrow end is facing out. This would help tie the wall back into the dirt behind it
The rebar sounds like a good idea. I would sharpen the end of each piece and drive them in about 3 or 4 courses at a time. You can overlap which courses you tie together and it will make it really strong. IE drive rebar through courses 1 through 4. Then lay two more courses and drive rebar through courses 6 to 3, in between the first set of rebar. Two more courses and drive rebar through course 8 to 5 above the original set of rebar. Keep in mind that if you do this you will need some serious equipment to tear it down.
Quikrete actually makes a product for this called
RIP RAP.