The main problem under XP is unruly software devolopers whose software doesn't play well under non-admin accounts. Not much Microsoft can do about that but withold certification.
You are absolutely right about them needing to break the backward-compatibility death spiral. They need to just pull an Apple and say, "After this, backward compatibility is not supported except in emulation mode".
But there is. Vista will allow non-admin users to appear as virtual admins. The software will not know the difference, but it will not be able to trash the real registry. The downside is that machines with more than one login will need to have some software installed multiple times, but disk space is cheap.