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It's known that <h1><h2> tags give kudos points (this still true yes?) - but this way of using them seems highly unethical to me...
Is this actually considered "wrong" / SPAM and are sites caught doing this demoted? Is there a "correct way" to use <h1> tags with CSS and not be unethical?
In the Results screen scroll past the list of errors (if there is one) and look at the section headed "Outline". The outline is built from the heading tags found on the page and presented as an indented bullet-point list.
If the outline does not look like a summary of your document then you are abusing the heading tag.
Whole paragraphs marked up as headings are pure spam. I would hope that the Google algorithm would penalise any heading more than 10 to 15 words long, or if more than 5 to 10% of a document was marked up as headings (those numbers off the top of my head).
I mean these "new" competitor pages appear to be purpose built JUST for AdSense revenue etc... and they jump ranked us - and the only reason / difference I could see for this was the <h1> tag - inbound popularity links were less - title tags were same as ours etc...
Since it makes sense from a document structure point of view and you can re-style it (reasonably) to fit your layout with CSS I generally don't see any reason not to use an H1 tag.