>> If the destination host is via a router then the router will respond
>> with its mac address and the packet is encapsulated with that mac
>> address and the router takes care of it.

This is called "proxy arp" and was originally implemented to allow  
subnetting, back when not all hosts understood subnetting.  Later it  
was generalized as replacement for routing knowledge in hosts in  
general.  Not all routers support full proxy ARP for all nets by  
default (it can cause interesting problems in conjunction with other  
routers, for example.)

As others have said, hosts USUALLY have some slight knowledge of  
routing, so that they will ARP for a router ("next hop") IP address  
rather than the final destination IF they decide that the final  
destination is "not local."  Hosts do not always have accurate  
knowledge of topology, however, so ARPs for non-local addresses can  
still occur.

I think "current philosophy" is still that hosts should never  
participate in actual routing protocols to learn routing...

> generates an ICMP redirect back towards your TCP/IP stack which
> can basically be interpreted as "I handled a packet you sent me which
> was destined toward x.x.x.x.   Next time send it to mac address
> xx:xx:xx:xx:xx:xx instead."

Not quite.  ICMP redirects are an IP-level thing, and do not mention  
nor contain and Mac addresses.  "I handled the packet to x.x.x.x, but  
next time use the router at y.y.y.y instead; it's closer."

The typical hierarchy generally goes like:

1) check arp cache for actual destination (performance hack)
2) check ICMP redirect table for dest.  (get "next hop" router)
3) if (local cable) then nexthop = dest; else nexthop = default_router
4) ARP for next hop.

Some hosts can have their default route point to an interface rather  
than another router, in which case anything that uses the route will  
get ARPed for (assuming that it's an ethernet-like interface, of  
course.)  I'd expect that some or many of the minimalist IP  
implementations avoid the router tables entirely and just ARP for  
everything.  That SHOULD work, given appropriate routers...

BillW


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