By DOUGLAS E. SCHOEN

There is a crisis in state and municipal finance. That much is clear. What hasn’t been fully understood is that the fate of the Democratic Party is bound up in the resolution of that crisis.

In the November midterm elections, the Democratic Party lost its congressional majority. The far graver threat to the party, though, is that its base is made up disproportionately of public-employee unions, liberals, trial lawyers and other special-interest groups.

A key reason for the Democrats’ extraordinary defeat in the midterms is that the party lost critical support from independent swing voters. In large part, as polls consistently show, this is because of the party’s big-government programs such as health-care reform, the bailouts, and the stimulus packages.

If the Democrats want to be competitive in 2012, they must move decisively back to the center. And unless they’re able to break the stranglehold that government-employee unions have on the party on policy, as well as in financial and political support, it will be virtually impossible for Democrats to restore fiscal health to states like New York and California.

Working-class families are fleeing the Democratic Party en masse, a trend that is likely to continue if their own economic situation remains weak in the face of ever-higher taxes, deficits and debt. These working-class voters see that public employees are continuing to receive more generous benefits and enjoy greater job security than they are. Support for the Democratic Party is now well below 40% with working-class voters who are unionized, and as low as 33% with whites who are not college educated.

By providing Democratic candidates the bulk of their campaign funding, public unions have essentially bought control of the party. This is particularly true when it comes to the politicians who control union contracts and pensions at the state and municipal level.

At the national level, public-employee unions spent more than $200 million to defeat Republican candidates during the 2010 midterm election. The American Federation of State, County and Municipal Employees—the main union of state employees—spent over $90 million during the campaign, and it was the top donor to the Democrats’ efforts to win gubernatorial and state-legislative races.

In New York, public-employee unions effectively run their own political party dedicated to defeating measures such as wage freezes, benefit cuts and tougher work rules. The Working Families Party, an alliance of labor unions, community groups and politicians, has disproportionate influence in the state assembly. A majority of members were endorsed by and appeared on the Working Families Party ballot line. So far, assembly speaker Sheldon Silver has resisted all efforts to make the kind of cuts in public-employee benefits that would make a meaningful dent in the state’s $9 billion deficit.

Democratic leaders are going to have to make hard choices in these states and others where public-employee pension systems are directly responsible for bringing treasuries to the brink of bankruptcy after years of reckless spending.

Mr. Brown in California and Gov. Andrew Cuomo in New York both spoke in their inaugural addresses about the need for public-employee unions to compromise and make some sacrifices. But talk is not enough. These governors, and the Democratic Party more generally, must develop and implement a new reform agenda that includes furloughs, layoffs, wage freezes and reductions in pension benefits—certainly for new workers, if not those currently in the system. This is not only essential public policy, it is essential politically for the Democrats to maintain their credibility.

Mr. Brown—who first gave California’s public employees the right to bargain collectively during his first term as governor—promised during his inaugural speech last week to review the benefits received by government workers. But he has said nothing about the specific steps he plans on taking to close California’s $28 billion budget gap or to address the growing labor contracts and swelling pensions of public employees. It remains unclear whether he will be able to negotiate the give-backs necessary to avoid bankruptcy. It’s more likely that he’ll push for a tax increase that will be unpalatable to voters if proposed and choke growth if enacted.

Mr. Cuomo has outlined a comprehensive plan to close New York’s $10 billion budget gap with specific proposals such as a property tax cap and a freeze on state salaries. While Mr. Cuomo has demonstrated the will to take on both the state-employee unions and Mr. Silver—who have rejected any compromise that would reduce public-employee pay—it remains to be seen whether he has the political heft to succeed where his predecessor David Paterson failed. Mr. Paterson was unable to negotiate give-backs, such as reductions in scheduled raises and an extended pay lag for public employees, with New York’s powerful labor unions, most notably the 1199/SEIU.

It wasn’t always this way. In 1975, New York Gov. Hugh Carey was able to secure the cooperation of New York City’s powerful unions as well as the financial community to narrowly avert bankruptcy. The result was a period of unprecedented fiscal health for New York, as well as significant improvement of the Democrats’ electoral fortunes—including the election of Andrew Cuomo’s father, Mario Cuomo, to three successful terms as governor.

Republicans are already making hard choices around the country: reducing union benefits, weakening their influence and limiting their right to strike and even their right to bargain collectively. Unless the Democrats engage in similar efforts, there will be a powerful new campaign issue for the Republicans to rally around going in 2012 and beyond.

Mr. Schoen is a political strategist and served as a pollster for President Bill Clinton. He is the author, with Scott Rasmussen, of “Mad as Hell: How the Tea Party Movement is Fundamentally Remaking Our Two-Party System” (Harper, 2010).