(Adds comments from U.S. Rep. Frank, muni analyst, details)

NEW YORK, July 31 (Reuters) - Most U.S. municipal general obligation and revenue bonds would get one or two notch upgrades from Fitch Ratings if it goes ahead with its proposal to bring them in line with its ratings for corporate bonds, sovereign debt and other offerings, Fitch said Thursday.

Tax-free debt sold by states, counties, cities, hospitals and museums would get the same upgrades if it is repaid from broad-based special taxes or appropriations from legislatures, Fitch, which is owned by France's Fimalac (LBCP.PA: Quote, Profile, Research), said in a statement.

The $2.6 trillion muni market has been rocked by the global credit crunch because one of its pillars -- bond insurance -- was knocked out from under it after most insurers lost their top ratings due to fallout from the subprime mortgage market.

Some state treasurers and Congressional representatives have urged rating agencies to recognize that municipal debt has an overall default rate of less than 1 percent, a much lower level than corporate bonds that often are rated higher.

Because munis are artificially rated lower, all the layers of government that sell this debt must pay higher interest rates, these officials say. On Wednesday, such concerns led Connecticut's attorney general to sue the top rating agencies.

U.S. Rep. Barney Frank, chairman of the financial services committee that passed a bill on rating munis and corporate debt on the same scale on Wednesday, said the Fitch move was a good one. But the Massachusetts Democrat said, "It doesn't mean we don't legislate."

Dick Larkin, a muni market analyst at Herbert J. Sims & Co in Iselin, New Jersey, said Fitch's proposal will give more bonds "AAA" and "AA" ratings, but he advised against using a formulaic approach to upgrade muni debt.

"These rating upgrades are important steps and shouldn't be treated cavalierly as a mechanical exercise," he said in a statement. "To do so raises credibility questions as to Fitch's commitment to thorough and quality surveillance of ratings."