Discounts are not applied if Payment or Enter Coupon Code pane on checkout screen are disabled

The discount checkout pane is required.

It can be hidden via CSS:
#uc_discounts-pane {
display: none;
}

Same thing with the payment pane.

I have both the payment pane and discounts pane activated but and it shows it correctly on the checkout screen after you "review order", however when I submit the order ( I am using paypal )... it does not show the discount. If I use "other" from the payment package module it works fine. Is this incompatible with the paypal module?

I discovered the issue.

In payment settings...

Under the "PayPal cart submission method:" section,

"Submit the whole order as a single line item." MUST be selected or the discount will not transfer over

You cannot select "Submit an itemized order showing each product and description."

I've had trouble with Ubercart and PayPal myself. I'll look into this because I'd like to get PayPal working on my site as well.

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This is by design. See http://drupal.org/node/576324.