A wage subsidy is a payment to workers by the state, made either directly or through their employers. Its purposes are to redistribute income and to obviate the welfare trap attributed to other forms of relief, thereby reducing unemployment. It is most naturally implemented as a modification to the income tax system.

The wage subsidy was proposed by A. C. Pigou in his book The Theory of Unemployment. It was subsequently advocated by American economists Edmund Phelps and Scott Sumner, American policy advisor Oren Cass, and British economist Tony Atkinson under the name of participation income.

The wage subsidy differs from universal basic income (UBI) in being limited in its scope to workers in paid employment, and does not generally seek to take the place of other benefits.

A wage subsidy is a payment in direct opposition to income tax. It can be presented as a modification to the operation of income tax below its threshold. In a conventional system the tax payable on an income y may be shown by the solid red line in the diagram, where θ is the threshold. Under a wage subsidy the employee's contribution to the state might be shown by the broken line below θ, being negative for workers on low income. s is the amount of the subsidy.

The same system may be viewed as having a wage-independent subsidy and a tax payment increasing in a certain way, or as a subsidy which varies with income, combined with a tax which varies in a different way.

It is not essential for a wage subsidy to be sufficient for a person to live on, as it is expected to be supplemented by income. If the pre-tax income of the lowest paid worker is y₀ in the diagram, then the amount they have to live on is equal to the sum of y₀ and the net amount the worker receives from the state through the tax/subsidy system; non-workers, on the other hand, are assumed to receive benefits determined separately. This differs from UBI in that the subsidy element is identified with the benefit paid to non-workers, and in which therefore the lowest paid worker receives enough to live on from the state and a further sum determined by their economic value to their employer. The increase in income from taking paid work may be more than is needed for incentive purposes.

In order for people to be motivated to take work and not feel demeaned by the compensation received, it is desirable for the post-tax income of the lowest paid worker under a wage subsidy system to be appreciably greater than the benefit they would receive when out of work. However, it would likely be less than the income the worker would receive under UBI; accordingly a wage subsidy system would impose a lower tax burden than UBI, which is the main reason for the preference shown for it by some authors.

A wage subsidy is well-suited for implementation through the income tax system, since its intended recipients are workers who are expected to be registered with the taxation authorities. It has been suggested that UBI should be implemented by the same means, which requires non-workers to also register and accounts for Friedman's choice of the term negative income tax for his UBI proposal.