On the basis of “Potter hypothesis” and related research, the generation process of “innovative offsets” effect under environment regulation is studied. It is found that the “innovative offsets” effect is mainly influenced by such three factors as firms’ innovation motivation, behavior and performance. These internal conditions and external environmental factors combine together and determine the generation possibility of the “innovative offsets” effect. Furthermore, the duopoly game model considering the above factors shows that the firms’ innovation motivation is stimulated not by the environmental regulation, but by the market competition and their own needs. However, the firms’ R&D investment and innovation performance are related to the intensity of environmental regulation. In the competitive environment, as long as the firm has higher R&D efficiency, knowledge absorption level and conversion rate of technology innovation, the environmental cost will be offset in a certain extent by the economic performance which is achieved by the technology innovation under the government subsidies policy. Especially, when R&D cooperation is carried out among firms, the effect of “innovative offsets” is more significant.