http://www.mute.fm/
btw, this probably should have been submitted as a link, rather than text.
>I'd love to see this be integrated into the OS at a lower level
The program is already at that lower level (it is necessary to read/write volume information.)
I debated about how the control should work (the way you described is how Earcandy for PulseAudio worked.) My reasoning is that you likely will only have to set up your background music one time so this way requires less configuration. Also if you listen to web-based music, you need to either run your music in a separate browser or configure it in mute.fm's built-in browser. I haven't gotten feedback from users on this aspect so far but could change out the heuristic if needed.
>Also, it would be nice if it could pause your music rather than fading it out.
It will pause instead of mute if you have specified how your player pauses (via a commandline or JavaScript.) You can change the fade duration to zero if you want to remove the fade.