My 1988 Diamondback Ascent also had partially-filled dropouts to begin with (though not quite to the same degree, see the PS.) It's something that was done toward the end of the horizontal dropout era to help put the freewheel in the best position for indexed shifting.

To gain a little more runway, I propped up the frame on its back end so that I could file straight down with a round file and some oil. I checked my work frequently to make sure I wasn't going above the line made by the upper portion of the dropout.

BTW, your dropouts don't need to be 2.5cm+ long to run an IGH. All that you need is to be able to get (almost) all of the slack out of the chain when installing the rear hub. Instead of filing anything, you could just get a half-link for your chain. That would give you finer adjustability in the space you have.


P.S. Not my picture, but here's what my dropouts originally looked like: