Note that the "Wallpaper Size" and the "Screen Resolution" are 2 different numbers.
While the screen resolution is 1200x800, that is, in landscape mode 1200 pixels wide by 800 pixels tall, you have to remember that several pixels are used by the notifcation bar along the bottom of the screen. You also have to remember that when you turn the screen your resolution is now 800x1200 and the wall paper rotates, in addition to that, when you scroll from one screen to the next the wallpaper pans. So in order to account rotation and panning, and ensure that your wallpaper always fills the screen, it needs to be much bigger than the actual screen resolution.
As it turns out, 1920x1408 is exactly the size it needs to be. Coincidentally this works out to be almost (but not quite) a 4:3 aspect ratio (its actually more like 4:2.95, but thats close enough. Point being - use any picture with a 4:3 aspect ratio and the xoom will be able to scale it so you can use (almost) the whole picture to fill the screen.