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 government on Wednesday abandoned a controversial plan to hike taxes on capital gains and dividends and softened its proposed new tax regime for the rich, keeping income tax rates below 50 percent after 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 that allows low-income residents to pay less but would require a contribution of up to C$1,000 for the wealthiest residents.

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

The recently elected separatist Parti Québécois had campaigned on abolishing the health surcharge put in place by the previous Liberal government to pay for healthcare. It proposed making up for the C$1 billion in lost revenue by creating two new tax brackets for high-income Quebeckers and increasing taxes on capital gains and dividends.

Marceau backtracked under heavy pressure from the political opposition and public opinion after it became clear that the government intended the measures to be retroactive. The changes would now become effective as of 2013 if passed by the provincial legislature.

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

"To this, we will add a reasonable income tax increase of 1.75 percent for the highest earners," he added.

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

Critics also argued that the changes to capital gains and dividends would penalize not only the wealthy but middle-class Quebeckers making a one-off profit selling real estate, for example.

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

Raymond Bachand, finance spokesman for the opposition Liberals, said an economic "disaster" had been averted for now but argued that the PQ government would not be able to fulfill a promise to eliminate the budget deficit.

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

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

($1 = C$0.98 Canadian)

(Editing by Louise Egan; editing by David Brunnstrom)

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