So, it's an audio problem and the VU's are reading correctly?
Let me start by giving you an overview of the routing and how the VU's are patched into the network.
In short, there are 3 different things that the VU's will show.
1. When the input selector is set to source, it's only showing whatever is being input into the machine. The machine just has to be powered on for this (the tape doesn't have to be moving). Most machines have a built in mixer for the line and microphone inputs. Think of the input pot, mic pot and the VU (set to source) as part of this mixer. In fact, if you wanted to you could input a cd player into the line inputs and a mic into the mic input and a PA to the outputs and with the selector set to source, your machine would act as a mixer and you could adjust the relative levels of the two channels of the cd and the mic to suit your purpose. The VU would reflect the sum of the signals inputted into the mixer for the respective channel.
2. When the input selector is set to tape, it's showing the output of the playback amp which could be fed from the 1/4 track or 1/2 track playback head depending on where the head selector is set.
3. Record level, this is where you set the level that will be recorded. Record has to be engaged for this function although the tape can be stopped in "Pause" . This signal is routed from the record amp, through the input pot(s) and mixer.
The levels measured by the VU's will be different between #2 and #3. If you recorded a constant signal which reads 0 VU during recording, the level would be closer to -3 dB on playback because the VU's are measuring two different signals.
So, it's difficult to separate problems between recording and playback since to hear a problem in recording, you have to play it.
The main way to rule out a playback problem is to have a reference tape which was made on another machine of known integrity. You don't have to spend the money on a test tape if you know someone with a 1/2 track machine that is working pretty well. Just have them make a tape with equal signals on both channels and see if it works on your machine. If it does, it's either something in the record section or the tape you're using.
Also, just for fun, try playing back the tape you recorded with the head selector switch in the other position. As you said before, if this machine had seen a hard life, someone may have rewired the switch backwards.
As far as the record section goes, did it ever work correctly for you before?