Theocracy is perhaps one of the oldest forms of government, having survived from the time of ancient Sumer 'til today. The meaning of theocracy is "rule by religion" or "rule by God." While it seems that if there was an all powerful, all knowing Being who wanted to personally run the government affairs that would be the way to go, the reality is far less appealing.
Theocracy is a flimsy excuse for people to manipulate religion instead of something private between the worshipper and the god. Men have long abused faith, presenting spectacles or claiming to have received guidance or counsel, which gives them the right to set themselves up as divine vessels, holy emissaries, or in some cases, gods themselves. The religion loses face to man's lust for power, people become disillusioned with the god/gods and begin to stray, and the government loses the loyalty of the people.
However, theocractic government does possess it's advantanges. It contributes to the unity of society as a whole. If every man has the same god and same set of beliefs, conflict between individuals is considerably lessened. Fear of punishment extends beyond the mortal into the divine realm. If you displease the government or break the law it is not only a threat to you in this life, but also in eternity.
If God actually did move among men today...imagine the peace, the absolute sense of justice that all would possess. Black and white lines would be clearly drawn with no dancing on the raggedy edge. Lawyers wouldn't exist...there would be no need for useless debate and strife-causing conjecture. It would be true utopia. But such things as yet are only dreamed of, and man still uses god shamelessly for his own ends.