The best algorithm to use here is a slowly rising one to reduce base morale. Personally, the best one I can think of is Logarithms.
Personally, I'd be in favor of removing the morale penalty entirely and replacing it with something else. For example, scale technology costs with the number of colonies you have and add an empire administration cost that scales with the square of the number of colonies you have. Alternatively, make the morale bonus multiplier apply before the morale penalty, as this allows percentage morale bonuses to be useful in counteracting the large empire penalty, whereas under the current system the number of colonies at which morale goes to zero is invariant with respect to the morale multipliers at a colony.
The current model is effectively a double penalty. You need to build more morale structures to counteract the morale penalty, which reduces your base production or production multipliers, and if you don't build morale structures, your average approval is reduced, which reduces your base production or production multipliers. You lose either way; how much you lose and whether it's better to lose in one way than the other or balance somewhere between them depends on the exact numbers. It'd be better in my opinion if it were just a straight cost.
Additionally, and less importantly, it's not a model that makes a great deal of sense. I'm less happy because the state of which I'm a citizen is bigger? Uh, why? I don't think US historical average approval rates differ significantly from UK historical average approval rates, and yet the US is a significantly larger state than the UK.