Well, I wouldn't sharpen. That'll just bring out noise. Maybe 15% at max if you insist.
Also, check out the capture guides at digitalFAQ.com, the top 4-5 guides that covers the theory and not how to use software.
For 720x480 (which will be overkill for VHS source), use closer to 7.0-9.0 bitrate. For 352x480 use 3.5-5.0 bitrate.
Your setup looks quite good. Nero 6 I think, not 9. And then the AMD would normally concern me, but if the hardware all works, then it's fine. The capture card, VCR and DVD player are all quite nice choices, thing I have too (though models somewhat different).
The pixellation is most definitely a result of inadequte bitrate. I made out a bitrate curve chart
(look near bottom of page for images) on this forum in the past few weeks. I'm adding a more complex version to the site guides, but the update is still lcoal on my PC, waiting until it's done before full upload (end of this week I hope).