Hmm not an easy case, since the bad result can be caused by numbers of influences.
First of all: the source tape itself; condition (noise etc). You can check this by playing the 8mm tapes on a TV. Although it will always look better on TV than captured, it gives you an idea. (when the images are bad on TV, it's time to panic )
Second: the conversion analog -> digital by your camera. I don't have such a camera, so I can't compare it with the capture quality of my pinnacle DV500. But it could be that the camera chip is not good enough. Only way to test this, is by recording a small part of the 8mm in DV quality on your harddisk (like you said; on the fly) and check out the quality of that file. If it's still good, you can start testing various encoding options with Premiere.
Premiere: VCD will always look blocky on a PC-monitor. However, it could still be a good and fast option to watch on a standard TV. I won't use VCD for archival purposes though.
S-VCD can be an option for archival, although you'll be limited to 30min storage/cd.
You could also try one of the other mpeg-options (mpeg1, but better mpeg2; not VCD/S-VCD compatible but good for PC-playback and archival)
Premiere offers various options for both VCD/S-VCD and mpeg1/2 files (bitrate, constant/variable bitrate, sound compression,..)
As a matter of fact, I'm digitizing some analog tapes at this very moment. I'm using 10 year old S-VHS camera tapes and I'm capturing them at 720 x 576 with the DV500. I don't have the time to edit them at the moment (about 30 hours of footage :s), so I just want to preserve some quality. I export the captured files with DivX5, at 3500 - 4500kbps (Adobe Premiere). The result looks very good to me, even fullscreen on a 19" LCD monitor. I compared the DivX compressed files with the same files in mpeg2 (DVD) compression and I like the DivX better.
One of the clips displays the date of the recording. For the DivX movie, the borders from the numbers are very sharp. For the mpeg2, the borders are blocky. Not that those numbers are that important, but it gives you an idea of the difference mpeg2 <-> high bitrate DivX