Austerity has come to America.

California faces a $25.4 billion budget deficit. Its newly-elected governor Jerry Brown recently proposed an austerity plan -- a combination of spending cuts and tax hike extensions -- that will seek to close that gap over the next 18 months. 

 

Illinois, which faces a $15 billion deficit, passed their own austerity measures by raising the state personal tax rate to 5 percent from 3 percent and the corporate tax rate to 7 percent from 4.8 percent. The tax hikes are expected to generate tax revenues of $6.8 billion per year.

 

Other U.S. state governments are also contemplating similarly measures. The Pew Center released a report titled Beyond California: States in Peril that identified nine states beside California that may need to brace for budget pains.

 

Illinois is one of them. The other eight are Arizona, Florida, Michigan, Nevada, New Jersey, Oregon, Rhode Island and Wisconsin. 

 

The fiscal situation of certain local governments may actually be worse. Last year, the municipality of Colorado Springs shocked the nation with its drastic austerity measures. These included selling the police department's helicopters, removing trash cans from public parks, and cutting back on street lights and bus services.

 

Moreover, from December 2008 to December 2010, local government payrolls went from 14.6 million to 14.2 million, state payrolls roughly stayed constant, while the Federal government's payroll increased from 2.77 million to 2.85 million.

 

State and local government payrolls, of course, may further decline as new austerity measures are announced. The first draft of Texas' (a relatively healthy state financially) budget already includes an estimated 8,000 public job cuts.

 

State and local governments and the federal government are headed in opposite directions.

 

While the federal government pushed through what's essentially a fiscal stimulus package for 2011 and 2012, certain state and local governments are going the austerity route.

 

One reason is that the municipal bond market isn't as friendly as the Treasuries market. 

 

Many Treasury buyers have few alternatives. The Federal Reserve is required to buy them because of quantitative easing. Foreign governments who have accumulated U.S. dollars in their foreign exchange reserves have little choice but to put a large chunk of it in Treasuries. 

 

The story of municipal bonds is entirely different.

 

While there is a natural demand for them, many investors can choose between the various issuers.  Therefore, specific state and local governments with weak fiscal health can easily be targeted by the market.

 

It's analogous to the European debt crisis because while it is inconceivable that the market would shun all European sovereign debt, it was quite easy to dump Greek bonds and flee to the safety of more-secure German bonds.

 

Scares in the bond markets are a major reason that Europe embarked on its austerity journey.

 

Now, concerned U.S. state and local governments have ushered in their own brand of American austerity. 

 

Email Hao Li at hao.li@ibtimes.com