I loaded up an existing world to try in Beta 1.2. It is the "Island In The Sky" map, with custom villagers.
The names above the villagers used to appear when you approached them but the name tags can now be seen from far away and even through walls, as if it was a player name tag.
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Problem is, when there is a group of them it looks messy and they are difficult to read.
It is probably an entity visibilty radius setting issue.
In Advanced video settings, If I turn off In Game Player Tags the names above the villagers disappear. I used a name tag on a pig and the result was the same, it could be seen from a long way away, seen through blocks and the name disappeared when player name tags were switched off.
Actually I don't want this bug to get fixed, it's really good to see name tags without having to look directly at the mob