I messed around with the gconf settings and it's straightforward enough to change the number of steps the applet uses to any value like so:

gconftool-2 -s /system/osso/dsm/display/max_display_brightness_levels 32 -t int

This will (of course) change the number of steps displayed to 32. Unfortunately there is some magic happening somewhere in the OS because regardless of the max brightness setting or even the other key "display_brightness_level_step" (I set it to 1) the levels are only significant from 0-5. Reading /sys/devices/platform/omapfb/panel/backlight_level shows that it automatically scales the value from the applet to 0-127, but only when the value is 0-4 (greater than that and it is always 127). FYI here's the tiny script I put together to show the values in real time:

while sleep 1
do
gconftool-2 -g /system/osso/dsm/display/display_brightness
cat /sys/devices/platform/omapfb/panel/backlight_level
echo "***"
done

"display_brightness" will show the exact value the applet is set to and "backlight_level" the actual value being used. I have a feeling that the applet doesn't directly set the brightness and the hardware management daemon (hald or dsme?) reads the value and does the scaling itself. Incidentally, there's yet another way to set the brightness:

chroot /mnt/initfs
/usr/sbin/dsmetest -l (0-255 for brightness level)
exit

Larry