Schizophrenia is typically associated with higher-level cognitive symptoms, such as disorganized thoughts, delusions, and hallucinations. However, deficits in visual processing have been consistently reported with the illness. Here, we provide strong neurophysiological evidence for a marked perturbation at the earliest level of cortical visual processing in patients with paranoid schizophrenia. Using functional magnetic resonance imaging (fMRI) and adapting a well-established approach from electrophysiology, we found that orientation-specific contextual modulation of cortical responses in human primary visual cortex (V1)-a hallmark of early neural encoding of visual stimuli-is dramatically reduced in patients with schizophrenia. This indicates that contextual processing in schizophrenia is altered at the earliest stages of visual cortical processing and supports current theories that emphasize the role of abnormalities in perceptual synthesis (eg, false inference) in schizophrenia.