Labour would offer tax breaks to persuade the private sector to pay a living wage as a way to boost productivity and cut welfare bills, Ed Miliband will propose on Saturday.

The Labour leader suggests that firms could be offered either tax reliefs on training or capital investment, or lower business rates, in return for paying the living wage.

Speaking to the Guardian on a campaign tour in advance of Thursday's local elections, the Labour leader said: "Living wage zones would work for everyone – the people who get decent pay, the employers who get a more committed workforce and the government that saves money on credits." He said the proposal was a labour market reform that tackled in-work poverty and lifted productivity without boosting the welfare bill.

Dismissing the language of "scroungers and skivers" used by some on the right, he said he wanted "responsibility for everyone to look for work and ... compassion for those that cannot find work".

He added: "I am not going to try to divide the country on welfare."

The independent thinktank the Institute for Fiscal Studies has calculated that for every pound spent paying the living wage, the Treasury saves 50p through not needing to pay tax credits and benefits.

The shadow Treasury team is now looking at the level of incentives needed to get employers to take up the scheme, and whether living wage zones could be established in industry sectors or geographical areas where a critical mass of employers are prepared to pay the living wage.

The measures are being considered as part of the Labour policy review, which is looking at a range of welfare reforms ranging from a compulsory jobs guarantee for the long-term unemployed, to restoring the contributory principle in some areas and switching housing benefit spending to house building.

Miliband said: "We are not going to be able to tackle the problem of in-work poverty through the tax credit system alone. It is a about changing the way the labour market works, using the power of government, making work pay and doing it in a way that gives the private sector real incentives. We have had enterprise zones. We can have living wage zones."

He said: "Twelve councils are now living wage employers and there are a 17 further in the pipeline. These councils are not only paying their staff the living wage, but also requiring the same of their contractors. We want to extend this progress."

The living wage is currently set at £7.45 per hour outside London and £8.55 in the capital. There are 200 employers accredited with the living wage campaign. The statutory minimum wage is £6.19.

The Resolution Foundation thinktank has calculated that if all those currently on the minimum wage received the living wage there would be a £2.2bn net saving to the public sector including higher income tax and national insurance receipts.

Miliband said he wanted to see local councils mandated to approach larger private sector employers to help create living wage zones.

He said: "It would be in central government's interest to get private sector employers over the hump to pay the living wage, so local councils could offer temporary rate subsidies or extra cash for training.

"The money would come from savings to the Treasury through lower tax credit payouts. It's an incredibly exciting idea since it is a way of persuading private sector there is a real incentive to pay the living wage.

"Employers might say at present this is just a cost to us but if we can show how they will benefit then that attitude changes. There is also increasing evidence that living wage employees are more productive and committed."

He added: "The whole living wage idea has come up from the grassroots. It has not come from the thinktanks. It is an example of the kind of politics that I want."

The idea is partly inspired by Arnie Graff the Baltimore-based community activist now working for the Labour party.

His aides said: "Low and stagnating pay is fast becoming a national crisis. In-work poverty has risen by 20% in the last decade and now stands at 6.1 million living in low-income households. Average wages have fallen since 2008, and the number of low wage, low skill jobs is expected to grow." Miliband, under renewed pressure over lack of policy specifics, has recently been buffeted by the aftermath of Lady Thatcher's death, unsolicited advice from Tony Blair and warnings from his biggest union backer that he will be consigned to the dustbin of history if he continues to take advice from Blairites such as the shadow defence Jim Murphy.

The Labour leader insisted he is energised by campaigning – making speeches in market squares on a pallet, not he insists a soapbox, the oratorical weapon of John Major. He said: "My biggest enemy is the people that say you politicians are all the same and governments cannot do things."

On Friday, he was forced in Chesterfield market square by a passing pensioner to make a public vow that if elected he will speak the truth, the whole truth and nothing the truth. Miliband said there is a terrible wall of cynicism out there, adding that Angela Eagle, the shadow leader of the House has just started a public inquiry into political disengagement.

He also insisted he was not on the wrong side of the welfare argument. He said: "I am incredibly confident of our position on welfare. We are in the right place. For the 230,000 young people aged under 25 unemployed for more than a year, or older people unemployed for more than two years, we guarantee you a job at the minimum wage, but you have to take the offer. It's a clear message that you have got a responsibility to work.

"At the same time I am not going to join George Osborne in saying anyone out of work is a skiver and a scrounger. Personally, I don't even think it works for them [the Tories]. I don't think my party is divided over this.

"I want responsibility for everyone to look for work and I want compassion for those that cannot find work. I am not going to try to divide the country on welfare."

He said he supported benefit caps set regionally since housing benefit, a large part of welfare income, has to reflect regional housing costs. "If the government is so confident about the national cap, why are they not implementing it across the country, instead of some regions?

"The fact is that for all their heavy rhetoric we will be spending more on welfare at the end of this parliament in real terms than at the beginning," he said.

Asked if he recognised himself as the most leftwing leader of Labour since Michael Foot he said: "I am firmly in the political centre ground, and I am addressing issues that go back decades. For the Brown and Blair generation, it looked like the Thatcher settlement had worked for most people. So Blair for totally understandable reasons was largely about challenging that social, but not economic settlement.

"For this generation looking back it becomes blindingly obvious that the Thatcher economic settlement did not work. We have an insecure labour market, wages falling and an economy only working for those at the top.

"We are about creating a different kind of economy for the future. Cameron is almost the business as usual candidate. That is why I think the ball is at our feet and it is our election to win."