The financial-market implosion and the coming transformation of the securities industry pose a risk to the national economy. But they especially imperil New York State, which for decades has built its budgets on the expectation of raising ever-greater revenues from a Wall Street that now no longer exists.

New York was once a great industrial state. But for the past quarter of a century, with occasional bear-market interruptions, the state’s dependence on Wall Street has grown as manufacturing has shriveled. Last year, nearly 18% of private wages in New York State came from the securities industry. That was up from 3% in 1980. Nationally, only 2% of private wages are earned in the securities industry. The average Wall Street salary and bonus last year was $379,000—more than six times the average for all private-sector jobs in the state. As securities jobs dry up, the economy in the rest of New York is not nearly robust enough to make up for the income and other tax revenue that will be lost.

Premeltdown, the securities industry accounted for one-fifth of the state’s tax revenues—and a large share of Albany’s net revenue growth over the past five years. That’s not even counting capital gains and dividends, or the profits that investment banks, private equity firms, and hedge funds generated for other businesses, from white-shoe law firms to black-car companies throughout the New York City metro area.

So New York will soon have a large hole to fill in its budget. When that happens, the financial crisis will get the blame, but the fundamental problem has really been out-of-control state spending that was built upon expectations of a continuous bull market on Wall Street.

During Republican George Pataki’s third and final term as governor, which ended in 2006, the “state funds” portion of the budget (the part that excludes federal aid) rose 19% when adjusted for inflation, including billions added by the state legislature over Gov. Pataki’s vetoes. The rate of spending growth was the fastest since Democrat Mario Cuomo’s second term in the late 1980s—which, not by coincidence, provoked the state’s worst fiscal crisis since the 1970s.

In January 2007, Democrat Eliot Spitzer became the first New York governor since Franklin Roosevelt to take office just as the economy was peaking—giving him room to engineer a soft landing before it was too late. But after campaigning on a pledge to control spending, Mr. Spitzer only made things worse by proposing or enacting 16% more in new spending, including a reckless promise of record school aid increases over four years before his admission that he was involved with a prostitute drove him from office the same week, it turns out, that Bear Stearns collapsed.

The new governor, Democrat David Paterson, was a reliable tax-and-spend liberal during his 21 years as a state senator from Harlem. But during his first five months in the governor’s office, he has proved a surprisingly strong voice for fiscal responsibility. In August, a month before the financial markets melted down, Mr. Paterson warned of a worsening financial crisis and coaxed legislators back to the Capitol for an unusual pre-election budget-cutting session.

Their negotiations produced an agreement to cut spending by $1 billion in fiscal 2009-10, which begins April 1. But this reduction is a drop in the bucket. Next year’s budget gap has probably mushroomed beyond $7 billion, over 12% of general fund revenues.

So now what? If the past is any guide, Mr. Paterson and the legislature will try muddling through the coming year with a combination of minimal spending restraint, debt-based fiscal gimmickry, fee hikes, and—worst of all—tax hikes, in a state saddled with the nation’s heaviest per-capita state and local taxes, 60% above the national average.

There’s a better way out of this crisis. Prior to the Wall Street storm, the numbers indicated that Mr. Paterson could close the gap and balance his budget merely by holding spending growth to zero next year. Now, with the meltdown on Wall Street, he will likely have to slash state-funded expenditures by 2% or 3%.

Plenty of short-term savings would result from downsizing state agencies and selling or privatizing assets like ski areas and golf courses. But with nearly three quarters of his budget dedicated to Medicaid, public schools and other local assistance, Mr. Paterson can’t begin to eliminate next year’s gap merely by nibbling around the edges of state operations. The main targets are obvious: school aid, which would rise by $2 billion under the current spending formula; and Medicaid, projected to increase another $1.7 billion. A cap on school property taxes, which Mr. Paterson has supported, is more urgent than ever.

Above all, Mr. Paterson and state lawmakers need to recognize that this isn’t just another cyclical downturn on Wall Street. In effect, the state government has been skimming the profits of a gigantic casino packed with drunken gamblers. Now the casino has shut down, and what replaces it will be more like a sedate church bingo hall. That’s a good thing on the whole. But it will require Albany to make a radical adjustment to its expensive and expansive lifestyle.