The following was gleaned from a PUBYAC contributor. If you're a member check 
out the archives for 1-22-2010.

 I did face painting for years through Girl Guides and found that the best thing to use was Watercolor pencils. These are similar to colored pencils but are in fact made with water color paint. You wet the tip and draw away on the child's face. They wash off easily and I have never had a child have an allergic reaction to them. I was an allergy kid myself so it was my mom that actually discovered them. They come in a wide variety of colors and are put out by a number of well known brand names, crayola or prismacolor. You should be able to get a pack of 12 for under $20 at Walmart in their craft section. Example: http://www.dickblick.com/products/crayola-watercolor-pencils/