Oh MAN, oh MAN. BTDT (been there done that) I spent weeks on this one, gave up, put the TEST SPINDLE results in by hand and ran that way for several months. Came back to the trouble and tried again. Exact same issue you're seeing; encoder pulses in diagnostics, TEST SPINDLE dosen't see them.
I got it to work, the last thing I tried was new firmware in the Galil card. Not positive that was it. Ernie, at Camsoft, gave me a list of issues to investigate - I found more than one problem from his list. Email me off list and I'll send you copies of coorespondence.
BTW, the are two modes IPM (inches per minute) and IPR (inches per revolution) The commands IPR or IPM changes the mode. I do remember pressing the "why am I not moving" button and seeing the message wrong mode, IPR; change to IPM. Changing this didn't help.