The successful establishment of China's emission trading scheme (ETS) could lead the next generation of global climate carbon markets in industrializing and developing countries. The allocation of ETS revenue from auctioning carbon emission allowance is important for the achievement of China's joint targets of economic growth, mitigation, and welfare improvement. This study develops a dynamic CGE model to evaluate the effects of different ETS revenue allocation mechanisms and identifies the proper mechanism for China's ETS design. Ten scenarios including business as usual (BAU), no ETS revenue allocation incentive (NA) and other eight ETS revenue allocation scenarios are designed. Simulation results indicate that the tradeoff between economic cost and environmental benefit exists under different ETS revenue allocation mechanisms. ETS revenue is suggested to allocate to household sector through reducing indirect tax and, after 2020, a certain proportion of ETS revenue could be allocated to production sector for improving energy-saving technology (i.e., STP mechanism). This study provides references for policymakers in China to design effective and realistic ETS-related policies. A similar study could be conducted to explore the proper ETS and the revenue allocation policies in other countries that have similar national conditions to China, such as other BRICS countries.