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I think religion is a personal matter and government should reflect that. Theocracy has really held back societies from the feudal fiefdoms of the middle ages to the Sharia law systems of today. Laws should neither favor a religion or prohibit it.

One of the biggest issues about this (in the US at least) seems to be prayer in schools. Of course, anyone is free to pray in the schools who wants to -- but you could not, for example, say a prayer over the PA system. Again, I don't think it would be right for the school to endorse a religion.. and people always have the options of private schools or home schooling.