Hence why this approach was stated as a privacy win by Apple. They catch the CSAM and they don't have to look at your photos stored online.
I for one am aware of this with iCloud and am still using iCloud for convenience (and by choice). If I were in need of better privacy, I can always use the iPhone without iCloud, and it will work. After this "in phone" watchdog implementation, that will not be the case. I will assume that Apple is constantly watching all my unencrypted content in the worst case, on behalf of state actors and intelligence agencies.
We have seen Apple give in to the Chinese government spying because it is the law there. US government could easily ask for this and also apply a gag order preventing Apple from being able to tell the user. The best situation is to lack such a tool.
If they are e2e encrypted they can't be distributed/shared without giving a key of some sort. Why not just scan them at time of distribution, and treat undistributed files the same as any local hard-drive (i.e. not their problem).
Almost all tech people know that iCloud (or its backups) are not encrypted, so they can decrypt it as they wish.. and those among us that are privacy conscious can comfortable turn iCloud OFF(or not sign up for one) and use the iPhone as a simple private device?