To make it short, cat is a command, like echo or cp, and few others, which cannot convert pipe redirected input stream into arguments.
So, xargs, is used, to pass the input stream as an argument to the command.
More details here: http://en.wikipedia.org/wiki/Xargs
As a former unix SA, and now, Python developer, I believe I could compare xargs, to StringIO/CStringIO, in Python, as it kind of helps the same way.
When it comes to your question: Why didn't they allow stream input? Here is what I think
Nobody but them could answer this.
I believe, however, than cat is meant to print to stdout the content of a file, while the command echo, was meant to print to stdout the content of a string.
Each of these commands, had a specific role, when created.