Update: Jack Balkan examined the arguments and thinks the government's position is farcical
"If the issue were not so grave, the government's arguments would simply be farcical. If the federal judiciary accepts the government's argument to dismiss the case without requiring the government to make somewhat finer grained distinctions about what it can and cannot disclose, it might as well close up shop. The state secrets privilege normally allows the government to refuse to disclose certain information within an ongoing litigation in the interests of national security. Now the Administration is trying to use the privilege to prevent litigation entirely, and, in particular, litigation that accuses the Executive of illegal and unconstitutional activity. Letting the government march into court and shut down inquiries into its possibly illegal actions on its mere say-so creates the worst of bad incentives. If the government can do so in this case, it can and will do the same thing whenever the legality of its actions is challenged in the future, and then we will be well down the road to the destruction of our constitutional system of checks and balances. What is at stake in this case is the principle that the Executive, like all other government servants, is subject to the rule of law.
I do not mean to suggest that the state secrets privilege should not exist or that it does not have considerable value. Rather, the claim is that the government must do more than simply assert the privilege...
At some point in the process, the court may decide that certain details of the government's program may not be disclosed and it may uphold the state secrets privilege with respect to some elements of the government's program. But that is a far cry from what the government is asking now. The state secrets privilege does not mean and was never intended to mean that the government need do nothing to defend itself other than tell the court that it is the government and therefore it cannot be questioned about its actions."