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.