#1 - Microsoft isn't talking about simply including SQL Server (or any derivative, like JET or MSDE) in Windows, they are talking about replacing the filesystem with it.
Currently, Win9x uses FAT/FAT32, Windows NT/2000/XP use NTFS/NTFS2/NTFS3.
This would replace NTFS with a database like filesystem that would use SQL-style syntax to query for files, folders, etc.
There are *many* benefits to using a database as a filesystem, and books have been written on the subject. Among these benefits, the key ones are typically referred to as TRC, which stands for Transactions, Recoverability, and Concurrency.
Here are a few links that discuss database filesystems (DFS):
http://unios.dhs.org/databasefs.html
http://groups.google.com/groups?q=database+filesystem&hl=en&selm=677o5m%245gj%242%40cronkite.lanminds.com&rnum=3
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