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As you likely already know, Microsoft accepts Paypal as a payment option for xbox purchases and for the Windows 8 store.
Once(a long time ago) I bought Microsoft points on the xbox console and choose paypal as the payment option. The payment went though right away - it was only months later that I realized that they charged my $2 not to my new credit card (that gave 1% rewards), but my debit card (no rewards at all). I realized I'd never been given the option to decide what payment method I wanted to use, and it just picked what it felt like using.
Now, far more recently, I obtained a paypal extras mastercard. I tried to buy a game on the Windows 8 store using paypal and I was charged... on the (no longer new) credit card it refused to use last time, and not the Paypal extras mastercard. Also, the paypal card was the entire reason to use paypal for this transaction (double rewards on paypal). I haven't had this issue anywhere else. Why am I not allowed to choose which payment method Microsoft uses? It's almost like it chooses at complete random!
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Normally when going the PayPal checkout process, you should have the option to select another funding source, not sure why you're not seeing that option unless everything is being done on the Microsoft side. That option allows you to choose another source associated with your account.
You may want to contact the PayPal Extras MasterCard Service Center for assistance by calling the number on the back of your card or call (866) 300-6432. As this is a PayPal product, don't know if there something in your profile setting that would help or not.

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