For those following this with hopes of a resolution, I wanted to add one
thing, and give a work around.

The behavior will work as expected if when you load Thunderbird, you
immediately go into the Account Settings and change this setting to
"Remove it Immediately", and click "Ok".  Then go back in and set it to
"Move it to this folder:"  and click "Ok". This seems to hold the
preference and work correctly until Thunderbird is restarted.  Once it's
restarted, you have to do this again.  Hopefully this can help the
developers come up with a fix.

WORKAROUND:

If you're like me, and you preferred this functionality in Thunderbird,
you can do what I did.  I downloaded the Mozilla KeyConfig add-on,
changed the settings for my backspace and delete keys to "Archive" the
message.  I then changed my Archive folder in "Account Settings ->
Copies & Folders" to point to my previously used custom "Trash" folder
(I had labeled mine "Trash_" to keep it separate from Gmail Trash.

This won't work if you right click an email and delete, however if
you're always using the keyboard for deleting messages like me, this
will hopefully give you an adequate resolution.

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Packages, which is subscribed to thunderbird in Ubuntu.
https://bugs.launchpad.net/bugs/885525

Title:
  Deleting a Gmail Message Always Sends Item to [Gmail]/Trash

Status in Mozilla Thunderbird:
  Confirmed
Status in thunderbird package in Ubuntu:
  Incomplete

Bug description:
  Thunderbird 7.0.1, Ubuntu 11.10

  Gmail accounts do not obey the setting in Account Settings -->
  [Account] --> Server Settings --> When I delete a message

  I changed this to move the message to Gmail's "All Mail" folder,
  attempting to imitate the Gmail web interface's "Archive" option.
  However, regardless of setting, the item always moved to Trash. This
  persisted after restart of the client. The settings save, but have no
  effect.

  Caveat: This was tested on two Google Apps for Domains accounts,
  though I suspect this behavior will happen with gmail.com accounts as
  well.

To manage notifications about this bug go to:
https://bugs.launchpad.net/thunderbird/+bug/885525/+subscriptions

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