I just bought a Lenovo tablet today. It has a 10.1 inch screen with 1280x800 resolution. Every time I rotate my tablet my screen rotates, which is expected, however my background pixelates. I have tried using a wallpaper app but it produces similar results and even tried to install a different launcher which still doesn't work. Not sure but cannot set a wallpaper the way I want it. Really bugs me out. I have tried resizing and cropping the wallpaper to be in a 2:1 ratio of width and height as a suggestion from lifehacker (https/lifehacker.com/5657727/whats-the-deal-with-androids-weird-wallpaper-requirements) but still the same. It shouldn't be a hardware issue.
Have you tried making the image larger rather than smaller? Setting it up to show correctly when turned rather than using the sideways view as the one to choose the image. When you have it the regular way, the image is set to the height of the device. Which is shorter than when you turn in. Hence the image tries to compensate and you get the issue you have. To get around it (I have tried this on other devices and it has worked well) get a larger image. While it will need to be wider than the view when turned sideways (as your image seems to be) it should look better.
You could also try a really good quality picture. Not all pictures are created the same.
If that doesn't help, then I can only think it is a tablet issue and you may want a different brand.