I actually ran Windows 7 on 1GB of RAM, and it *felt* just as fast as XP on the same machine. If you go with Windows 7:
1) Make sure you get the 32-bit edition.
2) Try to get a flash drive (preferably 2GB or 4GB size) to use for ReadyBoost; with 1GB of RAM, it will make a big difference (did for me).
Because of the new features and longer support period of Windows 7, I'd recommend you go with Win7. Besides, with operating systems, going with the latest and greatest is usually a good idea.
Quick note, Win7 Starter edition is only available for OEM manufacturers to preload on their low-end systems. If you are going to buy Win7 and load it yourself, go with Home Premium (the next version up from Starter).