The dog was probably freaked out by the weird costume. Humans do it all the time (I've been seeing Halloween decorations for sale since early August, which is terrifying) but we generally comprehend what's going on. Dogs may not fully understand the idea of a costume, much as a human infant might be scared by masks or beards (or the sudden removal thereof).
Anyway, this 1997 article titled Canine fears and phobias; a regime for treatment without recourse to drugs is kind of a fun read and has some interesting tidbits about, go figure, canine fears and phobias. One thing it discusses is the importance of the primary associations brought on by sight, smell, and hearing.
However with a fear of hot air balloons the dog will hear the propane burner and see the balloon but a primary (coming from the balloon), olfactory cue will be missing.
Missing out on that is enough to freak 'em out. This research article from the 1950s is a little more exact/thorough and has what you want. It's worth reading in more detail if this topic interests you, but the part that answers you is here (emphasis added):
Some at least of the test objects could not have been discriminated by smell, as with the bronze deer, or the mechanical turtle, and in the course of the work it was frequently clear that visual cues were affective before olfactory ones could have been. Vision also can dominate olfaction: fear of a modelled human head was observed although the model was completely wet with dog urine.*
Likely what happened was the dog saw a weird/scary/new person and, were upset that their vision and smell didn't match up, and continued being freaked out.
(*The urine experiment comes from this article out of 1944 Germany, in what is now known as Ethology, in case you feel like reading German.)
