The arrest of Harav Dov Lior, will not be good for the relationship between the state and its religious public. Harav Lior, may not be everyone's cup of tea, but he is certainly a tier one religious leader. His arrest is sure to be seen as another step of Hiloni suppression of religion. Already due to his high profile riots are breaking out.
The issue over which he has been arrested is also quite a tough question, one that should not be dealt with by the courts. Harav Lior was arrested on suspicion of incitement, for having written a "Haskama" – a forward to a book certifying its context – for a book dealing with halachic questions of when it is justified to kill non Jews. I have not read the book, so I have no idea whether its context was scholarly or just a right wing extremist rant. Regardless the book raises the question of the right to religious freedom of speech when dealing with subject matter that portrays certain parts of society in a less then flattering light.
The Talmud is rife with discussions and Halachic decisions that make liberal minded Jews cringe. Such comments are common in literature even as little as a hundred years ago. However what makes them different is that they have a practical religious context. And this is where the state is in a catch 22. The very fact that they are "Halachic" makes them dangerous as someone might act upon them. On the other hand being part of the Jewish canon of thought (the Talmud) can the state ban an honest discussion of these views, possibly leading to halachic rulings? Banning the publication of discussions of these sayings would effectively be censoring Jewish thought. This is a real threat to the freedom of religion.
When trying to decide my opinion on this matter, I come again and again to the following thought experiment. Let us assume that are we dealing with Sharia law and not Halacha. What would our opinion be if some imam started publishing works dealing with how and when you may kill Jews? Would we still feel such a strong need to defend his religious freedom?
I am not sure what the position of the state should be. Both positions of the argument are fairly clear and with substance. I am sure however that arresting for questioning Harav Dov Lior is not a smart move.