Hi Doug,
The best way to use the Trace to Paths function on an individual layer is to hide everything else first and just have the layer by itself. The green/red Z-contouring plane that the function shows is only really true and accurate when tracing the canvas to paths as a whole. When tracing individual layers it can be a bit deceptive because it doesn't take into consideration how the layer is being composited with the canvas, per its blend mode, and the tracing plane may not accurately depict what will actually be traced.
To make a text-layer that subtracts a certain depth you only need to make it's height the depth you want it to be and then move it up beneath the top of the canvas by the same depth. i.e. for 0.1" deep text you would make your text-layer's Z size 0.1", and if your canvas' Z size is 0.5" inches then you would set your text-layer's Z origin to 0.4". Then set the text-layer's blend mode to subtractive. This applies regardless of what is below the text-layer and how high it is. So, each 'step' in your project would basically have the same layer Z origin and Z size with only different text and XY position.
If the text-layers are subtractively blended with the canvas, and they are the only things in a group (with the canvas' Z-fill set to the bottom of the canvas) then you will not see anything when that layer group is active. In order for the text to show it will need a different blend mode, or the canvas Z-fill to be set to the top of the canvas (not the layer's Z-fill as shown on the layer's properties, but the Z-fill under Canvas Properties).
If you want the text to blend the way you were originally trying you can invert the text-layer and set its Z-fill to the top of the canvas, and set its blend mode to Minimum. This will allow you to set the Z origin of the text-layer to the exact Z coordinate you want the text to be cut down to. The top of the layer (i.e. Z origin + Z size) will need to be at least as high as the surrounding material the text will be cut into.
I think you should be able to get the text Trace to Paths to work and then can use the medial-axis carving operation using a Depth Offset down to the material depth you want to cut into. There's no way to directly convert text or anything else into single paths to use with the paths-carving operation, unfortunately. The closest thing would be a function that calculates a medial-axis path but that will leave all sorts of extraneous paths on there at corners and stuff. It won't directly generate 3 lines for the letter 'H', for instance.
If you switch your text-layers to use the minimum blend like I mentioned above, you should be able to toolpath Group 2 if it only contains text-layers that are set up that way, but you will still need to set your Canvas Properties' Z-fill to the top of the canvas first, then you will be left with the text as pockets that you can generate toolpaths from.
I will do up an example project you can look at and email it back to you later today :)
- Charlie