Both the subsidy on the investment in abatement of pollution and the tax imposed on the pollution level, subject to possible audit, can be considered two important incentives contributing toward alleviating the costly externalities to pollution generated by optimizing economic firms. Also, under existing environmental regulations, firms are often required to self-report their compliance status to reduce necessary supervising and legal enforcement costs. Assuming the related tax rates of pollution are exogenous, this paper examines the interplay between environmental subsidy and audit policies, specifically under a self-reporting regime, to shed light on some policy implications. One of the major results indicates that, as environmental audit is difficult and costly, the subsidy on the investment in abatement of pollution will be relatively more effective and justifiable. Nevertheless, under a self-reporting regime, there is not such an obvious policy substitutability between subsidy and audit measures as that in Guo and Wang (2004), which has no self-reporting regime.
