What do you think of this thing that I've come up with dubbed "University Model"...
Where states are heavily reduced in size, to the point that they encompass only a small town or university sized area.
This increases competition between states heavily, and gives people a lot more freedom.
If you've ever gone to university, you know what I mean. Security guards patrol the campus and act as police, there are numerous facilities available for use, and most things are paid for by your uni fees, or 'taxes'.