What does it mean when they say a horse is paddling and how will that affect the horse's ability to perform well in upper level dressage tests?

Paddling is a deviation in movement of the front legs such that the lower leg rolls out instead of moving exactly forward and backward in a straight line as viewed from the rear. Most likely the horse stands with its toes of the hoof pointing inside toward each other. How severe it is depends on the degree of variation. A slight variation shouldn’t be a big problem. A large variation in movement or stance will affect the forward motion of movement, thus creating a greater potential for lower scores in dressage.