The O/S services still have to be available to the applicatoins
Whatever you run in VMs must still provide system services like I/O, memory management and higher level APIs to applicaitons. You could run an app on a bare VM (which is how VM/CMS, the grand-daddy of them all worked) but you would have to link to libraries providing those services.
For some apps such as DBMS platforms you could arguably make a case for running them with a minimal set of kernel services directly linked into the server. Oracle have been banging on about DB appliances built like this since at least the 1990s.
However, there aren't many application s for which this would be particularly beneficial - at least where it would be cost effective to do this. Developing applications for that type of architecture is much harder and more expensive than developing against a platform that provides a comprehensive set of system services. In short, there is little to recommend this type of platform outside of a handful of specialised applications.
Providing system services through the hypervisor simply turns it into an operating system with a very heavy context switching overhead, likely to be quite inefficient. Far better to provide an O/S kernel with paravirtualised drivers against raw I/O and memory seriices provided by the hypervisor, which is largely how it's done now.
If you wanted a minimal kernel it is certainly possible to strip Linux or one of the BSDs down to a minimal set of system services, but this may or may not be particularly useful. One possible benefit is improve runtime security by removing unnecessary services that could provide attack vectors - in which case you've really just re-invented OpenBSD.
One point to note is that we used to get on just fine without hypervisor sprawl and that *nix or mainframe architectures could run enormous portfolios of applications without needing to split each one into it's own VM. Modern VMs are largely a solution to problems originating from the Windows DLL Hell era, and that has been a substantially solved problem for a decade or more..
That is not to say that VMs aren't useful, but in many cases they are a sledgehammer to crack a walnut. The current technology of paravirtualised services where the O/S kernel has drivers to support services provided reasonably efficiently by the hypervisor allows the O/S to be used with or without a VM. The O/S provides the system services and the VM allows multiple O/S images to be consolidated onto a shared hardware platform. You can run your O/S and applications against a VM or against bare metal. Job done.