Businesses that sign up to paying the living wage will be given a 12 month tax break worth up to £1,000 for each worker under plans unveiled by Ed Miliband.
The Labour leader has pledged to introduce make work pay contracts to raise wages for millions of low-paid workers if he takes the keys to No 10 at the general election.
For each low paid member of staff whose earnings are boosted, firms would receive a tax rebate worth around £445 on average although it could potentially reach £1,000.
The announcement comes ahead of a major speech next week when Mr Miliband will set out how tackling low wages is key to solving the squeezed living standards.
He will warn that Britain risks "an era of growth without prosperity" as wages stagnate while household costs continue to rise.
"Ordinary families are doing much worse than the averages would suggest because people at the top continue to enjoy faster wage rises than everyone else," he will say.
"For ordinary families to keep up, we don't need average wages to just creep higher than prices. That will still leave millions of people worse off.
"We need the kind of strong increases in wages that will genuinely make people all across Britain better off.
"Wages for millions of families have been stagnant or in decline for far too long now.
"Last year there were 4.8 million people who earnt less than the living wage. That is up 1.4 million in just the last four years. We've now got to the point where more of the people bringing up families in poverty are in work than out of work.
"And low wages aren't just bad for working people and their families. They are driving up the social security bill too, as the country has to subsidise more and more low paid jobs with tax credits and benefits.
"This Government pays more out on support for people in work than it does for unemployed people.
"So to those who say we can't afford to do anything about wages in our country today: I say we can't afford not to. The Tories are indifferent to millions of families being locked into a permanent cycle of low wages and poverty."
Companies that sign up to the make work pay contracts in the first year after the election will receive back 12-months' worth of the resulting increased tax and National Insurance revenues received by the Government.
Any extra savings in lower tax credits and benefit payments, along with increased tax revenues in future years, would be used to cut social security bills and help pay down the deficit.
Mr Miliband will say: "For every extra pound employers pay up to living wage, the Government saves almost 50p on lower tax credits and benefits and higher tax revenues.
"That is why the next Labour government in our first year in office, will offer make work pay contracts to employers.
"If employers agree to move to paying the living wage to their workforce, we will provide them with an incentive, offering them in the first year the money that government would receive in higher tax revenues.
"The result: working people get higher wages, employers get support to help to make the transition to a living wage, government cuts the cost of social security for the long term.
"And we make a clear statement about the future of our country and our economy: Under a Labour government: work will pay. And that together, we can tackle the cost of living crisis."
The living wage is £8.55 in London and £7.45 in the rest of the UK although that will be uprated tomorrow.
RMT general secretary Bob Crow said: " Today's living wage announcement is a cop out by the Labour Party.
"Poverty pay should not be an option and the only solution is to raise the statutory minimum wage to the current living wage rate, making it legally enforceable and slamming the door on cheapskate employers looking for an opt out.
"Offering employers a tax break to try and drag them into paying a decent rate just smacks of corporate welfare and will stick in the throats of millions of people who have had their benefits cuts and frozen."
Research by KPMG found that 21% of employees are being paid less than the living wage, up 1% from a year ago.
Marianne Fallon, head of corporate affairs at KPMG, said: "Low pay is a real problem in Britain, particularly at a time when the cost of living is rising at a faster rate than earnings. This was underlined by the Social Mobility and Child Poverty Commission recently. People on less than the Living Wage can seriously struggle to make ends meet. Whilst it is still not easy, earning a Living Wage can make a huge difference to individuals and their families, enabling them to afford a basic standard of life.
"For many businesses, paying the Living Wage rate need not actually cost any more. At KPMG, we have found that better staff performance and motivation combined with lower absenteeism and turnover cancels out the extra salary costs.
"Living Wage Week is the perfect opportunity for employers to consider whether they can make the move. It may not be possible or practical for everyone, but all employers need to do what they can to address the problem of low pay. In practice, transition to the Living Wage is a phased programme that does not happen overnight. Making an initial assessment is an important first step."
Katja Hall, CBI chief policy director, said: "We are pleased that Labour is taking a voluntary approach to the Living Wage.
"The minimum wage acts as a floor on pay, protecting workers.
"This scheme may help some firms pay more, but many companies simply can't afford it.
"The best way to boost wage growth in the longer term is to build a sustainable recovery and invest in the productivity growth that will boost wages."
John Cridland, director general of the Confederation of British Industry, said Labour's policy would not benefit all employees.
Giving the example of a shoe shop owner, he said the employer 's ability to pay the living wage depended on whether customers were prepared to pay extra for its products to cover the increase.
Mr Cridland told Murnaghan on Sky News: " It's good to see today the Labour Party talking about an incentive rather than a stick. This might help some businesses that have a skilled employee who has become very productive to pay them £8.55 in London."