To the people worried about fungibility, they need to remember that this blacklist via tagging is not centrally enforceable. It is an opt-in tool that exchanges can use to avoid stolen XEM at THEIR discretion. NEM foundation can not enforce this blacklist so it's not a problem in relation to centralization.

As far as how the tagging might work, I would assume they might exempt known legit addresses like exchanges or community funds etc which would be trivial to do. I also assume they will not flag small amounts. Any innocent accounts that receive stolen funds and are flagged could simply surrender the stolen funds they received to have the tag removed. They could even automate all of this.

1) An account receives say 100+ stolen XEM.
2) System then flags the account via mosaic and includes a link to a PSA about the tag in the transactions message.
3) The PSA (public service announcement) explains instructions on where to return the stolen funds.
4) Account holder sends stolen funds to recovery account.
5) Flag is removed from account. In reality they can't automatically remove the flag so they could set a second flag that designates the account was cleaned. Or they could be sent enough of the mosaic to allow it to be removed manually.

Definitely feasible and an interesting way to address the issue of stolen funds.