This is an interesting thread. There are a few more inputs that I would like to add, tho.
On the topic of arahats, there are mahayana arahats and theravarda arahats. I have read about something that Hsuan Hua said about a practitioner who got annoyed at the fish who was swimming in the pool near his cave and distracting him with the flapping of the fishes' tale, and he made a wish/grudge that he would reincarnate as a bird to eat it. The practitioner somehow attained arahatship, but after many aeons, he fell from his self absorption and really reincarnated as a bird. Hsuan Hua also describes arahats being practitioners who got stuck during a certain stage of meditation and instead of opting for full enlightenment, opted for the bliss of one of the dhyana levels instead. According to him, this stage is actually reversible. Thus, arahatship is more or less a kind of suspended animation, where 0 karma is created by the body, speech and mind, and therefore there is no way to experience its results. Since there is no way to experience suffering, compassion, wisdom, skillful means cannot arise so how can be fully enlightened? The theravardans however, believe that arahatship is equal to attaining enlightenment and that is the ultimate goal, to be free of suffering. The word arahat is also used to describe a being who is completely free of suffering, and is also used to venerate the Buddha.
On the degeneration of tulkus, my friend have encountered a tulku who was recognized by the dalai lama. he was even given robes but he refused to return to the monastery, in exchange for sexual pleasures. He is very boastful and tells people he does Chod practice as well as fire pujas, and claims that he is of the same incarnation line as padampa sangye. He also boasts that the land deities gives him money and he has not worked in a year but still has money. Personally, if a tulku can become like this, it is extremely sad indeed as it seems that he has completely forgotten about his purpose to spread the Dharma and instead engage in samsaric activities....he claims that he still wants to benefit sentient beings....through an environmental group. How can a dharma teacher become this way?