Vince,
what I get of this is that the OP is either talking about the way the category links are created, or they literally installed MU in a subdirectory called blogs.
Assuming the first scenario, by default MU adds "/blog/category" to all category links. It's similar to how the standard version of WP adds "/category" to all the category links, if you are familiar with that. It's through the list_cats, or wp_list_cats functions where this additional information is being added.
As I mentioned in another post, I'm not sure why this is so, but there must be some reasoning behind it. I can only guess at it.
If you look at the permalinks settings for an individual blog, you will see at the bottom it talks about "/taxonomy/tags", and the category base. This is what I think the OP is talking about.
I want to say IIRC that there was a problem with pages and categories clashing with permalinks in the standard WP version, which is why post cats all are linked to as /category/whatever.
I did read on the main WP forums a fix that does a preg replace or something of that nature in one of the core files, which removes the "/category" from the url generated by list_cats/wp_list_cats. I've tried that out on a standard WP install, and it works fine without any problems. However, my guess is when there is a match between a page slug and a post slug that the conflict exists.
So if you had a page that had a slug of "portfolio", for example, and then made a post category called "portfolio", if you go to yoursite.tld/portfolio/, the software doesn't have a clue what to bring up. Does it render the page or category?
So, my best guess is that with /category (or /blog/category in MU's case) is being added to prevent the possibility of the above referenced type of collision.
You may have noticed that the actual permalink to the post itself doesn't have this in there.
IMHO, requiring the slug to be unique regardless of page or category, would correct the issue. Running a check when adding a new page or category against the other's slugs, would most likely work. If you're adding a page, check category slugs, or if you're adding a category, check the page slugs.
While I'm sure the majority of people are bright enough to not add a page and a category with the same slug, with something on the scale of WP and WPMU, the dev's have to build it as idiot proof as possible. So, I can understand the err for caution.
Although for MU, instead of making /category into /blog/category, personally just /blog would be fine for me.
Or, I could be out in left field, but that seems to be the underlying issue.