Windows 7 included what you describe as a feature called "Windows XP Mode," which would launch applications inside a Windows XP virtual machine which was closely tied to the host OS. It worked really well for a lot of applications which weren't ready for Win 7 yet.
It wasn't really that closely tied, if I remember. It simply used Terminal Services to run a single application on the server. You've long been able to open local documents with remote applications, and have the general experience very close to a local application.
Windows Virtual PC, the core of the technology, is more akin to VMWare, VirtualBox. The "Windows XP Mode" part of the equation was that Microsoft offered a pre-installed image of Windows XP.
While the virtual environment integrated somewhat with the base (eg audio, printers, some networking shares and hard drives), it still is a separate window running a separate virtualized OS. I'm not sure I would call that too tightly integrated.
Nonetheless I personally found it handy nonetheless to run the occasional very old 16-bit application.