I've seen worse. She wasn't dressed in a swim suit there... It's not like she was showing anything. I didn't exactly agreed with the make-up (but I was young at the time and when I was 16, I thought this stuff was only for adults), but the whole ensemble was okay.
I think Buffy over-reacted because it was her little sister. She wasn't ready to see her grow up and being interested in men. We all know Buffy took the role of mother, even if she didn't want to admit it ("Do I have mom hair?" 7x01). And with her "career", being over-protective was kind of in the job description. So I guess seeing Dawn act like a woman instead of a teenager (or what teenager she wanted her to be) was a shock.
I agree that the dancing was a bit too provocative, though...