Padding is also there because screens got a lot bigger and higher resolution in the 17 years since Windows 7 came out.
This is even true with laptops since bezels have dramatically shrunk in size.
That's not a justification for padding, it's a justification for scalable UI. A lot of those "classic" windows dialogs do not scale well on high DPI screens but they still work great with a mouse even if their scaling is ugly. The padding is just there for touch-friendliness.
I don't even agree with the premise in the first place if I'll be honest. Windows 11 is almost the same scale as Windows 7. The taskbar is the same size, the tray icons are the same size. Most of Microsoft's applications seem to all be roughly the same scale.
I've heard a lot of complaints about the Settings app being a downgrade from Control Panel and being too padded or whatnot, but let's not forget that the old Windows XP era Control Panel couldn't even be maximized. It was just one size no matter what.