By establishing a panel dataset ranging from 2003 to 2007 with annual survey of industrial firms and prefecturelevel data on firms investment in pollution control, this paper investigates how regionlevel environmental regulation affects manufacturers total factor productivity and how governmentfirm collusion compromises this effect. We find that firms contemporaneous TFP decreases by 1% when the intensity of environmental regulation, measured by the ratio of firms pollution abatement and control investment to value added, increases by 1%. The possibility that local government colludes with polluting firms mitigates this negative marginal effect. We believe the reciprocal governmentfirm collusion enables the favored firms to escape from rigorous regulation with lenient regulations and penalties. The policy implication of this paper is the central government should adopt unified law enforcement to escape from prisoners dilemma of environmental regulation. We also provide justification for the reform of vertical management system in monitoring polluting firms and enforcing laws by environment agencies.