Ok, after disassembling a lot, I made an attempt at correcting the horizontal error. Had #1 snug but not full tight, loosened #2 & #3 a tad. Tapped the headstock near #2 to rotate the HS CCW. I tightened #1 first, then #2 then #3.
Took another 0.001 pass. Really didn't believe what I was seeing. (0.7 tenths) So I took another pass of 0.001, reasoning that making another cut shouldn't make any difference, but should remove effects of the headstock adjustment a little. The second set of measurements was better.
If I believe my second set of measurements (avg of 7 measurements at TS, and 8 at the HS) the HS is 1.96044" and the TS is 1.96086". This is a difference of 0.00042", with the TS being larger (still). I've reduced the error by a factor of 2. It took me a while (6 readings each) before I really settled down taking measurements. (On the second set.) Had to get a feel for the right sensation as I rotated the micrometer off the maximum. If it didn't feel right, I looked at the measurement, but rejected it. After a dozen measurements or so the feel seemed to be more consistent.
Too be honest, I'm going to wait a bit. Wait for the iron to relax. Then take another cut and measure again. 4 tenths isn't bad for this class machine, although I'd like it a tiny bit better. Tapping the headstock with my machinist hammer seemed like it was doing nothing. But it took off about 0.0005 of the error! From my former, non-machinist point of view, this would be black magic. Now I know better.
Need the level for the next step.