The zoomed-out size of XII is about the size of XIII sprites. That is still "zoomed in", as they're not 100% (to see them at 100%, look at the select screen - they're very small, like the sprites in Hard Corps Uprising). This is 100%:
[ig]http://dreamcancel.com/wp-content/uploads/2011/07/Elizabeth-XI-alt-custom.jpg[/Img]
Way too small, so they need to be bigger, but not 200% big. That is the whole issue, and why they're blurred in both arcade and console. Sprites look awesome at 100%, 200%, etc. If you go into fractions, you get pixel-doubling. Staircases inside staircases.
That is what is being hidden with blur.
Personally, I think pixel-doubling looks fine at XIII size (pop XII in and walk away from the other character). It's a perfectly acceptable middle-ground between what WE want (sharp, clean pixel art) and what the average gamer wants (little pixelation). SNKP disagrees, though, as reports say there's no option to turn the blur off.