The Effects of Minimum Wage on Taxation

One advantage of logarithmic taxation based on minimum wage is that it automatically accommodates changes in minimum wage due to rising cost of living and inflation. Increasing the minimum wage will decrease the tax rate across all income strata.

Let us look at a previous example where a person earns $100 in a place with a minimum wage of $10:

Tax Rate = [20 * log (100/10)]%

= (20 * log 10)%

= (20 * 1)%

= 20%

Net Income After Tax = 100 – (0.20 * 100)

= $80.00

Let us now increase the minimum wage to $12:

Tax Rate = [20 * log (100/12)]%

= (20 * 0.9208)%

= 18.4%

Net Income After Tax = 100 – (0.184 * 100)

= $81.60

$1.60 has been saved, which may seem insignificant. However, cumulative inflation over decades may eventually lead to a minimum wage three times the original value. Let us see how this same person would be taxed if the minimum wage is $30:

Tax Rate = [20 * log (100/12)]%

= (20 * 0.5228)%

= 10.4%

Net Income After Tax = 100 – (0.104 * 100)

= $89.60

It is clear in these examples that continuous increases in minimum wage will eventually lead to significant deductions in tax rate. Using a logarithmic approach to taxation based on minimum wage ensures a tax rate formula that is stable over time.

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How will this affect policy making? Because an increase in minimum wage will lead to less taxation, there is incentive among lawmakers to keep the minimum wage reasonably high so that everybody would be taxed less. This will not only benefit the higher income strata who would lose less of their earnings from taxes, but more importantly, minimum wage earners would be happier due to their raw increase in net income.

The disadvantage with a high minimum wage is that the government would be gathering less taxes every time the minimum wage is increased. Furthermore, corporations may be able to hire less employees due to high wages, hence promoting unemployment. However, the latter concern may be addressed if corporate tax was also based on minimum wage. This will be tackled in a later article.

 

Primer to Logarithmic Taxation Based on Minimum Wage

One of the problems with income tax is the use of income brackets to determine how of a person’s wages should be taxed. Although progressive, these brackets are rigid, arbitrary, and vulnerable to inflation, discouraging people to pursue greater incomes for themselves in order to pay less taxes. Furthermore, such system of taxation requires constant updating to keep up with costs of living and inflation.

Logarithmic taxation seeks to address all these problems by eliminating income brackets altogether and providing a single, smooth, non-linnear, progressive increase to income tax as personal income increases. To make such a system favourable for minimum wage earners, the minimum wage itself would be an integral variable in determine the tax rate.

First of all, the equation for determining the tax rate must be formulated:

Tax Rate = [20 * log (N/M)]%, where

• N = Net income before taxes
• M = minimum wage
• The calculated value is rounded down to the lower tenth of a percent

Using this formula, every ten-fold increase in income above the minimum wage would result in a 20% increase in tax rate.

For purposes of illustration, let us say that the minimum wage is $10 per day. The tax rate of a person earning minimum wage would be as follows:

Tax Rate = [20 * log (10/10)]%

= (20 * log 1)%

= (20 * 0)%

= 0%

Hence, a minimum wage earner has no income tax. Let us now look at a person earning twice the minimum wage ($20):

Tax Rate = [20 * log (20/10)]%

= (20 * log 2)%

= (20 * 0.3)%

= 6%

Net Income After Tax = 20 – (0.06 * 20)

= $18.80

Here, it is shown that a person earning twice the minimum wage loses less than $2. Now, let us see a person earning ten times the minimum wage ($100):

Tax Rate = [20 * log (100/10)]%

= (20 * log 10)%

= (20 * 1)%

= 20%

Net Income After Tax = 100 – (0.20 * 100)

= $80.00

Here, we see a significant portion of income lost ($20), which is the entire wage of the second example. However, the person earning ten times the minimum wage still keeps eight times more money than the minimum wage earner, and he can still afford a comfortable lifestyle.

Now, let us look at someone earning one hundred times the minimum wage ($1,000):

Tax Rate = [20 * log (1000/10)]%

= (20 * log 100)%

= (20 * 2)%

= 40%

Net Income After Tax = 1000 – (0.40 * 1000)

= $600.00

In this example, up to $400 is lost to taxation, forty times the minimum wage, yet the person earning $1,000 still keeps sixty times more money than a minimum wage earner.

Let us turn things up a notch and see how someone earning ten thousand times the minimum wage ($100,000) is taxed:

Tax Rate = [20 * log (100000/10)]%

= (20 * log 10000)%

= (20 * 4)%

= 80%

Net Income After Tax = 100000 – (0.80 * 100000)

= $20,000.00

Here, an astounding sum of money is taxed, and the person still keeps two thousand times more money than the minimum wage earner. To put that into perspective, the minimum wage earner has to work every day for nearly five-and-a-half years to earn that $20,000.

It would be prudent to peg the maximum tax rate at 80% for now because using the same formula indefinitely would eventually result into a 100% income tax, which is absurd. However, the same logarithmic system can be applied recursively to the remaining income after 80% taxation. This will be addressed in a later article.