I've never had any problems from PVC dust, but if you do there are several things you could try. A hat, dust mask, safety glasses, apron and a long-sleeved shirt should keep most of the dust off of you. Also, using a knife for initial shaping will vastly reduce the amount of dust generated.
If you want a smooth PVC bait, you're going to have to do a lot of sanding. Here's my technique:
I start by carving the blank bait to a more or less rounded shape with a knife. A utility knife works fine for this, but any knife you use should be sharp.
Next, use a dremel tool to rough-sand the bait all over. There's no need to try to get it very smooth at this stage; you're just trying to get it a bit smoother than the knife left it.
Hand-sand with 80 grit sandpaper. All sanding subsequent to this will be done by hand.
Now put a couple drops of water on the bait and wet-sand with 80 grit sandpaper.
Now repeat the hand-sanding process above with 120, 220, and 500-600 grit sandpaper. It helps if the sandpaper you wet-sand with is a little more worn than the piece you use for dry-sanding.
Now if you want to get the bait even smoother, use a piece of paper to polish the bait. I don't always do this step, but it does make the surface a bit smoother.
Finally, I spray on a clear water-based sealer just before painting. I generally use a mix of U-40 Color Lock and Seal Coat Lure & Jig Finish, but any clear water-based finish should work. With this coat I just build up enough paint over the bait to make it as smooth as possible for the final paint. This coat is not actually sealing the bait; it's just there to provide a smooth surface for painting. It also helps prevent the PVC from expanding while heat-setting paint. I didn't have many problems with PVC baits expanding, but since I started sealing before paint I've never had any problems. Actually all that happens when PVC expands is the surface gets a bit rough; the bait is still perfectly functional, but it affects how the finished bait will look.
There you have it. It takes a bit of elbow grease, but the end result is a smooth PVC bait that is easy to paint.
Ben