You've asked some good questions. The consequences vary depending on if the home was a primary residence, an investment property, second home, etc. Generally the banks treat debt forgiven on a short-sale of a primary residence as earned income, and issue a 1099 in the amount of the debt. However, per the new Mortgage Debt Reduction Act, the howowner could write off the taxes on the bad debt, with some restrictions.
This can change if the property owner is insolvent, they are short-selling an investment home, etc. A short sale will certainly have a negative effect on your credit, but not as much as a foreclosure. Credit hits will depend on many factors, such as overall credit history, but you can count on a foreclosure knocking out up to 300 points on your FICO score. It can also take up to 3 years before you can qualify to buy another home.
A short sale will cost you approximately 125 points on your FICO score, and it may take up to 2 years before you can buy again.
Hope that helps.