I see dead formats.....
Oops, wrong movie.
As you observed, VHS is pretty bad to start with. Then you're going to cram 2.5 hours on a DVD - things will get ugly pretty quick.
A DVD is MPEG. While you can upload MPEG to YouTbe, it isn't the best format. (On the other hand - you're starting with VHS, so it's not a quality hit that most would notice.)
But, you don't just "pull off" a video from a DVD. Sure you can use markers and play selected chapters from the DVD, but that isn't a file you can upload to You Tube.
If you want a DVD, then encode MPEG and AC3 using the DVD Architect templates in the "Render As" menu. If you want to upload the individual songs to YouTube, then encode each song into a separate file. (Burn those on a separate DVD as a data disk). I would probably use the Sony AVC encoder. I don't know which version of Vegas you have, but there is a YouTube template in Version 11.
Steve Mann
MannMade Digital Video
http://www.mmdv.com