Users will want to use applications that require features of the earlier OS version, and newer ones that require newer features. They don't want to have to switch to using a VM because old apps would only run on that VM.
Putting apps from the VM on the primary desktop is something they have already done on WSLg. Launching Linux and X server is all taken care of when you click the app shortcut. Similar to the parent’s ask, WSL2/WSLg is a lightweight VM running Linux.
In many ways the old API layers are sandboxed much like a VM. The main problems are things like device drivers, software that wants direct access to external interfaces, and software that accesses undocumented APIs or implementation details of Windows. MS goes to huge lengths to keep trash like that still working with tricks like application specific shims.
They did that with Windows 7. Win 7 had an optional feature called "Windows XP Mode" that was XP running inside of a normal VM.
Backwards compatibility isn't their biggest problem to begin with, so that wouldn't be worth it. In effect they already did break it: the new Windows APIs (WinRT/UWP) are very different to Win32 but now people target cross platform runtimes like the browser, JVM, Flutter, etc. So it doesn't really matter that they broke backwards compatibility. The new tech isn't competitive.