Separatist Quebec gov't backs down on controversial tax hikes

* PQ scraps plans to hike capital gains, dividend tax

* Tweaks income tax hikes for rich to keep rate below 50 pct

* Replaces flat health surcharge with progressive tax

By Rita Devlin Marier

MONTREAL, OTTAWA, Oct 10 (Reuters) - Quebec's new governmenton Wednesday abandoned a controversial plan to hike taxes oncapital gains and dividends and softened its proposed new taxregime for the rich, keeping income tax rates below 50 percentafter a public outcry.

The finance minister in Canada's French-speaking province,Nicolas Marceau, also said he would replace an annual C$200($204) flat tax for healthcare with a progressive tax thatallows low-income residents to pay less but would require acontribution of up to C$1,000 for the wealthiest residents.

The package of changes will raise an additional C$400million annually to pay for the province's health services, hesaid. The income tax hikes alone will raise at least C$322million.

The recently elected separatist Parti Québécois hadcampaigned on abolishing the health surcharge put in place bythe previous Liberal government to pay for healthcare. Itproposed making up for the C$1 billion in lost revenue bycreating two new tax brackets for high-income Quebeckers andincreasing taxes on capital gains and dividends.

Marceau backtracked under heavy pressure from the politicalopposition and public opinion after it became clear that thegovernment intended the measures to be retroactive. The changeswould now become effective as of 2013 if passed by theprovincial legislature.

"The measures I am presenting today will not be retroactive.The Liberals' health tax will be replaced by a new fair andprogressive contribution that takes into account everyone'scapacity to pay," Marceau told reporters.

"To this, we will add a reasonable income tax increase of1.75 percent for the highest earners," he added.

Taking in account federal and provincial income taxes, theplan the PQ initially put forth would have pushed the totalincome tax rate to more than 50% for those earning more thanC$130,000. Under the new plan, the combined rate will remainjust under 50 percent for those earning more than C$100,000.

Critics also argued that the changes to capital gains anddividends would penalize not only the wealthy but middle-classQuebeckers making a one-off profit selling real estate, forexample.

The PQ won the Sept. 4 election with a minority of seats, soit needs the support of at least one of the two oppositionparties to pass tax changes. Both have opposed the moves.

Raymond Bachand, finance spokesman for the oppositionLiberals, said an economic "disaster" had been averted for nowbut argued that the PQ government would not be able to fulfill apromise to eliminate the budget deficit.

"At least on that we succeeded in protecting the economy ofQuebec," he told reporters.

"Nicolas Marceau has acknowledged today that he's incapableof managing the (fiscal) hole of 2012, of respecting thecommitments made by the government of Quebec," he said.

($1 = C$0.98 Canadian)

(Editing by Louise Egan; editing by David Brunnstrom)

((louise.egan@thomsonreuters.com)(+1 613 235 6745)(ReutersMessaging: louise.egan.reuters.net@reuters.com))