Allow it? I encourage it!
Which means, actually, that it very seldom happens. But I tell my players to play their characters, and if there's an in character reason to kill another character, I'll not only grant full XP for the killing, but I'll give a special reward too.
The one time it did happen it was very amusing. Both players had in their possession a one use instant kill item. Neither knew exactly what it did, of course... (the home-campaign I'm talking about introduces several very high powered magical items to first level characters, which they will theoretically learn to use throughout the game).
One of them DID know that he was holding an item that would certainly kill the other in one use. The other didn't even have a clue as to what he was holding (but it was his only weapon).
What happened? I had them roll their dice on the table. The attacker one, thought that he'd try to kill the defender without the special item first (as the defender looked to be asleep, he'd earlier Sensed Motive something was going on). The defender instead of making a retaliatory attack went defensive when he saw he was suddenly at 2 HP, the attacker then decided to use the item...
Result: One level two PC's body destroyed, and soul removed from the fabric of space time. One magic item capable of killing a god removed from the hands of the party... one party member aghast when he learned what he'd wasted on CR2 kill.
End result: No more inter-party conflict. They've learned that I won't 'mommy' them, I'll allow their characters to do whatever foolish thing they tell me their characters will do. The defender was indeed being an @55 originally.
In that same game they got an artifact evil sword. One with no ability to mind control, but it does occasionally ask for sacrifices. One's captured in battle are fine for it, but I've several times offered a special reward to the player if he did something nassty to another PC. So far it's been refused. If he took me up on the offer? I'd give out the reward, another PC would be dead (I'd offer something conciliatory to the player who just got killed), and we'd have all learned something about the character, he would have made a definite and strong character decision, one that everyone could see and appreciate. Not doing it? Also a strong character decision. And one that would be completely impossible for him to make if I were going to baby the players and protect them from each other.
I do tend to discourage evil PC's in my games. I state right at the beginning that I'll allow at most one person to start out their character as evil, and that I don't recommend it because most likely a PC WILL die eventually because of it. But I will allow people to become evil later. If the entire party wanted to evolve into fighting against each other, then that's an entire adventure plot or two I can use on their next characters, after these have killed each other off.
In the end I've found that it leads to PC's being more respectful of each other. When a player knows the GM will not allow inter PC conflict, he can do whatever he wants, and some PC's can become downright antisocial. When he knows the GM will not only allow player killing and player abandoning, etc, but he'll instead reward it, he knows that he HAS to be in good standing with the party members. As it should be.
If the players in my game all decided to "go evil", I'd go for that. In fact I've offered them several incentives to do so. Right now they're on a (spanning 20 total levels) quest to save the world. The being they're saving it from will definitely reward them well for switching sides. They could almost certainly RULE the world instead of saving it, if they went over to the "Dark Side". Strangely this has the most evil inclined in the group playing more good than ever. He's seen the dark side and, as he put it, "What's the point of ruling the world like that? I want to rule the world MYSELF, and I want to rule a good world."
His original character write up did actually include him being power hungry and with an ultimate goal to either rule the entire world or as much of it as he could. Now he's been given several opportunities, and he's turned them all down. THAT's character!