From the video it appears that the UI lags noticeably behind the user's actual motion. A friend who has demoed Natal mentioned it suffers from a minor lag as well.

This strikes me as a major problem when one is expecting the screen view to reflect their current position rather than their future position. For precision tasks it is akin to giving your mouse cursor acceleration and then training yourself to decelerate at the correct thresholds.

I thought Apple had a patent that covers display sensors integrated into a flat panel display:

http://www.macnn.com/articles/09/05/19/sensing.display.paten...

Not sure about the patents but your link says:

the Apple patent proposes interweaving photo sensors alongside each pixel projector

whereas the linked video shows photo sensors around the edge of the screen, which they claim is superior to photo sensors between pixels. A subtle difference, so not sure if Apple's patent applies.

They aren't around the edge of the screen, or along side each pixel - they're on another plane, behind the LCD. The LCD modulates between the image being displayed and a pinhole mask.

Its a great idea, but I wonder what its uses would be considering any long term use would make the users arm tired.

3D editing with a 2D input device is clunky. If you've ever used a tool like Blender and tried to position a vertex in three dimensions with your mouse, you've discovered you have to do it twice from two different angles. With a system like this combined with a stereo display, you could simply move your hand to where you want the vertex to be.

Of course there are other ways to achieve that, but there must be tons of other applications that require 3D input, that's just the first that came to my mind. Most of what we do every day in real life is manipulating objects in 3D.