I'm glad you got it figured out.
If you ran the batch file, it likely did rebuild the icon cache. (A reboot is required after running the batch file.) But simply rebuilding the icon cache doesn't always solve all problems.
I think icons are only displayed up to 48 x 48 if they are 48 in size, or smaller. Each program/file can have different sized icons. It looked like your desktop was set to use icons which are 128 x 128, but many programs don't have icons that large therefore it can only display icons up to 48 x 48. Changing the desktop icon size removed the big square around the icons because they weren't large enough to fill the square.
Take care.