The municipal bond market and state and local governments could benefit more from the election of Democratic Sen. Barack Obama as president than his Republican opponent, Sen. John McCain, according to an analysis of their tax, economic recovery and other proposals, as well as interviews with market participants and economists.

However, many of those interviewed expressed a great deal of skepticism about whether either candidate would be able to carry out his policies and proposals, given the current financial crisis.

The steps taken by the federal government to combat the crisis are already sending the federal deficit upward and any decisions about further spending will come as spending for Social Security, Medicare, and Medicaid are also projected to increase significantly.

"I think a couple of things are going to be restrictive on what either candidate does," said Craig Elder, a fixed-income analyst at Robert W. Baird & Co. in Milwaukee. "What you want to do and what you can do are two different things sometimes."

Much of the focus of market participants has been on the candidates' tax policies.

Obama's tax proposals could make municipal bonds more attractive to investors, especially those in the upper income tax bracket who would be facing a tax increase, Elder said.

"Higher tax rates make municipal bonds more appealing on an after-tax basis," he said. "Obama's tax plan would make munis more attractive simply because of after-tax yield."

The reductions in the marginal income tax rates that Congress enacted in 2001 and 2003 at the urging of President Bush are at the heart of the candidates' tax proposals. The cuts in the tax rates are scheduled to expire after 2010. The 10% income tax bracket would disappear and the 25%, 28%, 33%, and 35% brackets would rise to 28%, 31%, 36%, and 39.6%.

Obama would extend the 10%, 15%, 25%, and 28% tax rates but immediately restore the 36% and 39.6% rates for the highest income taxpayers - and adjust them so that they apply to individuals with incomes of more than $200,000 and married couples with incomes of more than $250,000.

The Illinois Democrat also would increase the maximum rate on capital gains for families making more than $250,000 to 20%, raise the top tax rate on qualified dividends to 20% from 15%, still keeping it below the pre-2001 level; and enact new and expanded tax breaks for workers, retirees, homeowners, savers, parents, students, and new farmers, according to the nonpartisan Tax Policy Center.

McCain would permanently extend the 2001 and 2003 tax rate cuts, increase deductions for taxpayers supporting dependents, reduce the corporate income tax rate, and allow immediate deductions for investments in certain capital equipment.

Both candidates would extend and index the "patch" for the alternative minimum tax to prevent additional moderate income taxpayers from having the tax apply to them. McCain proposes a permanent extension of the patch and would increase the exemption from the AMT by another 5% per year after 2013, according to the Tax Policy Center. The Arizona Republican has also talked about, but not formally proposed, eliminating the AMT for individuals.

The AMT applies to interest earned on private-activity bonds and some governmental and 501(c)(3) bonds and results in higher yields on such bonds. It took effect in 1970 to prevent high-income households eligible for several tax breaks from paying little or no taxes. However, the AMT is not indexed to inflation, so more taxpayers become subject to it each year.

A repeal of the AMT would increase the value of the private-activity bonds and 501(c)(3) bonds that had been subject to it, according to market participants. But this would not affect housing bonds, which were permanently exempted from the AMT in the American Housing and Economic Recovery Act, which Bush signed into law on July 30.

Tax Rates V. Munis

Under Obama's tax plan, the top 1% of wage-earners would face a $19,000 average tax increase, or a 1.5% reduction in after-tax income, by 2012, according to the Tax Policy Center. McCain's plan would cut taxes for those same wage-earners by more than $125,000, raising their after-tax income an average of 9.5%.

"Tax rates are one of the single most important determinants of relative value for munis," said Evan Rourke, vice president and portfolio manager at MD Sass Investors Services Inc. in New York. When the Bush tax cuts went into effect, Rourke said muni investors lost 10 to 20 basis points in relative value. Investors could see that value return if the Bush tax cuts are not extended, he said.

Richard Ciccarone, managing director and chief research officer of McDonnell Investment Management LLC, said long-term muni bonds are currently yielding about 6%. If the tax rate for the highest tax bracket rose to 39%, the taxable equivalent yield on that same long bond would be about 8%. A 5% yield for an investor in the 40% tax bracket is equivalent to an 8% return on a double-A, 15-year bond, he said.

"That would be a time for joy given the current market," Ciccarone said.

Of the two sets of presidential and vice presidential candidates and their spouses, only McCain's wife, Cindy, holds tax-exempt bonds. Her tax return for 2006, recently released by the campaign, reports $19,284 in tax-exempt interest earnings and $4.2 million of adjusted gross income for the year.

But Ciccarone argued that higher taxes are not good for job creation. "It would seem to be a deterrent to economic growth," he said.

"It is a positive if taxes go up [and] the bonds that you own will give you a better income," said Matt Fabian, managing director of Municipal Market Advisors in Concord, Mass. "But don't expect some big performance bump out of the muni sector any time soon. Expecting performance out of municipals right now is extremely difficult."

Muni bond prices have fallen this year as most of the major monoline bond insurers have lost their triple-A credit ratings.

Market participants also caution that it will be difficult for either candidate to follow through with their proposals given the current financial crisis.