The settings work as they are explained the edit usergroups function sets global permissions. You can under edit categories in admin fine tune the settings by specifying individually which groups can do certain permissions to individual categories.
Now my suggestion since I see something wrong in the code where it is using the viewing perm not the uploading perm is edit the pp-inc.php line 2447 that the line I have bolded below appears as I am trying it as there is a slight variation.
Code:
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