I wish I could fly, and that would be cool too, but that's not going to happen either. As I've already said, you need to use a computer for this. The Xbox simply doesn't have the hardware or drivers to do this.
To throw you special folks a bone, MilkDrop is OPEN SOURCE. It was not developed by the XBMC team, simply adapted for use inside of XBMC. You can actually use WinAmp to take a line input and feed it through a visualization, such as MilkDrop. What's more with the additional horsepower of a computer you'll be able to get better/more consistent framerates @ better resolution with lower latency than an Xbox-based rig, plus have a lot of other readily available visualizations to choose from in addition to MilkDrop.
In case you forgot, Xbox has a 733 MHz CPU with a TOTAL of 64 MB of RAM.
It does NOT have a normal operating system and thus you can't simply plug in random devices to it or expect drivers for said devices to appear out of thin air. To my knowledge, there is no homebrew project that uses the Live headset for audio input, so even if it is in the XDK its not very well understood by the community at large.
It took me like 60 seconds to find this on Google:
This is a live audio input plugin for WinAmp 2.x/5.x:
http://home.hccnet.nl/th.v.d.gronde/
This is other links that may prove useful:
http://www.milkdrop.co.uk/links.htm