@Lil Shenron, nice inquiry. I just skimmed the first couple pages and then became impatient, so here goes. I very much agree with you that non-human races in D&D, whether the canonical rules or most games that I have played in, don't have the same kind of exotic, truly fantastical feel that I find to be more aesthetically interesting. Actually, Tolkien's elves (not Peter Jackson's) are, to me, "real elves" - they truly feel otherworldly, of the faery realm. Peter Jackson tried but didn't quite get there.
But the other part of this is that players sometimes want special characters. They might want to be Drizzt, not Mr. Standard Elfy Elf with bow and cloak. With that in mind, you can still let the players play what they want, but with the understanding that they are probably outliers. Maybe an elf was taken in an orc raid and then sold in a slave auction, then escaped and grew up on the streets of a sprawling tropical metropolis. That elf might become a rogue or assassin, end up with tattoos and piercings, and perhaps feel a distant sense of longing for something else. I think the key is if the players want something outside of the norm they need to be able to contextualize it.
I think, in the end, what you are talking about is certainly valid, but that the onus is on the DM to create the context, what "normal" is. If you want more mystical, otherworldly and rare elves, do that. If you want dwarves to really feel like a difference race that has emerged from the earth itself, do it. But then let the players decide how they want to relate with that and encourage them to do it well. And, most importantly, have the world respond accordingly. If one of your players wants to play MC Shiggy the elf bard and the party meets a group of elves and he says, "What up, bros," then have the "real" elves treat him accordingly. In other words, don't cater to your players not taking things seriously or roleplaying absurdities.
As for kitchen sink, one of my all-time favorite RPG settings is Talislanta which has been called a "fantasy zoo" - it is more psychedelic, in a way, than traditional fantastic. But it works, and I think because it intends to be kitchen sink, it is going for that. I think what you are talking about is similar to the monty hall effect with treasure: too much of a good thing waters down the specialness.