U.S. businesses pay trillions of dollars in employee compensation, a substantial fraction of which is deductible for tax purposes. This deduction reduces the taxable income of businesses, ultimately lowering business tax burdens by hundreds of billions of dollars. With a few exceptions, the tax code confers the same deduction to a business for every dollar of employee compensation, regardless of whether that compensation goes to an employee earning millions or an employee earning minimum wage. This is consistent with a pure Haig-Simons income tax, under which any business expense incurred ought to be deductible dollar-for-dollar. But many, if not most, tax policy objectives are inconsistent with a pure income tax, and the U.S. tax code is accordingly replete with substantial deviations from a pure income tax.

This Article considers what would happen if the deduction for employee compensation also deviated from a pure income tax. It finds that allowing employers larger deductions for compensation paid to low-wage workers would counteract persistent deficiencies in the U.S. labor market. A larger deduction for low-wage workers would incentivize businesses to both hire more low-wage workers and pay them more. This would decrease the number of workers earning paltry wages, reverse the decline in U.S. labor force participation, restrain the employer market power exerted in many local labor markets, and correct the negative externalities from low-wage work.

As part of its analysis, this Article considers how a larger deduction for low-wage compensation might be funded, focusing on funding sources that synergize with a larger compensation deduction for low-wage workers—including higher business tax rates and smaller deductions for high-wage workers—and it details the tradeoffs associated with these different policy options. This Article also explains why behavioral frictions may make an employer-side subsidy a more effective labor market intervention than an employee-side subsidy, such as the earned income tax credit (EITC).