I have all of my contacts in my gmail account with decent resolution photos (very few under 720p). You would think that this would be the optimal way to have your contacts stored but it seems that when the contacts sync with the people app their photos magically come out looking like pixelated garbage. It's absolutely atrocious.
I have this same issue with album art. I synced my entire collection with Google Music. All the artwork looks great when I view it on my computer and on my old school Droid Incredible but again, once it syncs it becomes pixelated. The majority of them become unrecognizable.
I seriously hope that someone has some ideas as to how to fix this. It would be a shame to have such a cool looking OS/Phone plauged with so much ugly.