If you wrote code to crawl the tree generated from that XML, you'd have text nodes (of whitespace) in one, but not the other.

That's what I thought - I don't think I've ever seen an application that would bother with that difference.

You're using that application right now - XHTML takes the difference into consideration. Consider the <pre /> tag:

  <pre><b>Hello!</b></pre>

is rendered differently from

  <pre>
     <b>Hello!</b>
  </pre>

Good point! :-)

The difference is a big deal to applications that use XML as a markup language (marking up documents and text), as it was designed to do originally.