Industrial effluents and municipal wastewaters are increasingly finding their way into freshwater bodies, posing serious health and environmental challenges. In this paper, the potential for industrial wastewater remediation through agroforestry is explored for a peri-urban farming region in India. Farmers are incentivized under a payment for ecosystem services (PES) mechanism to convert their farmlands into poplar-based agroforestry and utilize industrial effluents for irrigating trees. Additional income can be derived through sale of poplar timber which enhances the attractiveness of such a PES mechanism. A dynamic optimization model compares farmers' optimal land use allocation to a socially optimal case. Further, the firm's effluent discharge outcomes are compared to an alternative arrangement where it is fined for discharging untreated wastewater into waterbodies in the absence of the agroforestry remediation option. Results support the attractiveness of such PES mechanisms in addressing the industrial effluent discharge problem while simultaneously mitigating the effects of water scarcity through wastewater reclamation. The optimal level of tax required to accomplish complete treatment of effluents by polluting firms is several times higher compared to PES payments. Further, the incentive to convert farmland into poplar plantations improves with PES payments but declines with higher profitability of agricultural crops. © 2021 World Scientific Publishing Company.