Many New Yorkers are in for a surprise. State government is running out of money and soon won't be able to pay all its bills. State tax revenues are forecast to be $20 billion lower than projected spending over the next 21/2 years.

How did we get here?

For one thing, the private sector economy has been declining, particularly in upstate New York. State coffers were filled by taxes generated by the financial services industry in New York City. Since the real estate and stock market bubble burst in 2008, state revenues have precipitously declined.

Meanwhile, nothing has been done by Albany to lower the cost of state and local government in recognition of the severe private-sector economic recession.

Public pension costs are exploding and taxpayer contributions will triple in the next few years. Local governments and school districts are routinely hamstrung by state laws dictating how employee contracts are negotiated, significantly tilting the playing field in the direction of unions against the interests of taxpayers.

State mandates drive up costs. In New York, local school property taxes are approximately 70 percent more than the national average. Property taxes in Nassau, Suffolk, Rockland and Westchester counties rank in the top 10 in the nation. But high taxes don't only affect the affluent downstate counties. When taxes are measured as a percentage of home value, nine of the top 10 taxed counties in America are in upstate New York.

New York schools now spend an average of more than $17,000 per pupil, ranking first or second in the United States, but academic results aren't commensurate with the investment.

New York and its localities have among the highest debt in the nation. In addition, the state and its localities have more than $150 billion in unfunded employee health insurance obligations.

The state and its citizens have a mess on their hands. We must immediately lower expenses to deal with the cash shortfalls over the next three years, and permanently lower future costs to ensure long-term private sector economic growth.

First, Gov. David Paterson should ask the state Legislature to declare a fiscal emergency authorizing him to freeze scheduled salary and benefit increases to all public employees in the state. There is legal precedent for such a freeze: It was done by state law for New York City in the 1970s and for Buffalo earlier this decade. Conservatively, public employee salary increases to be paid in 2010 are estimated at $2.5 billion to $3 billion statewide. Such a freeze would also significantly reduce out-year budget gaps.

Second, freeze state aid to schools for at least the next two years. However, school districts can manage only if wages and benefits, which represent 75 percent of school spending, are frozen as well. The alternative to a pay freeze would be damaging layoffs of teachers.

Third, enact a less generous pension plan for new public employees. This would save approximately $50 billion over the next 30 years and help ensure long-term fiscal health for the state and local governments. Overtime should also be eliminated in calculating pensions.

Fourth, sweep away state laws that only serve special interests and add to taxpayer costs, especially those that are related to labor negotiations and building construction.

Fifth, eliminate the ability of the governor and Legislature to incur new debt without voter approval. Take the credit card away from the Legislature and require pay as you go financing for most capital projects.

Sixth, adopt a property tax cap, similar to that in place in Massachusetts since 1980. Property taxes in the Bay State are 30 percent to 40 percent less than those in New York, yet services are as good or better. Limiting property taxes is essential to the state's economic survival. New York is facing a genuine economic crisis. The state can once again be restored to prosperity and health, but only if we honestly address the self-inflicted causes of our high taxes and declining economy. The best time to start is now.

John Faso was the 2006 Republican candidate for governor and a former state Assembly minority leader. He is a partner in the law firm of Manatt Phelps and Phillips LLP.