Actually identifying the letter name can be a good exercise for improving sight reading skills. I have seen this in several work books on the subject. However, to be a good sight reader you need to develop an internal automatic response to seeing the notes and relating that to a correct body movement that generates the desired sound from the instrument. There are multiple connections that get built up in the brain when one reads. I agree with all the responses that suggest that identifying the letter name is a step that one doesn't necessarily need or have time for but if one is trying to get past a deficit in reading it can be helpful. This depends on how the person learned music early in the process and what connections are in good shape. We learn several things when we pick up an instrument.
There is learning music, independently of an instrument, learning the patterns of western music, the major scale, intervals, etc.
Learning to identify what you hear and replicate it with your voice or other means.
Learning to master a particular instrument which involves a lot of muscle memory.
Learning to read by some means. To get instructions on what to play and when. This can be SMN, TAB, or some other set of instructions in a script.
I suspect a lot of young people who've started out self teaching on an instrument may have a good idea what letter names correspond to the keys, frets and strings, of their instrument but perhaps have not yet developed a good ear. In this case calling out the letter names will invoke a physical response in the hands. Perhaps this is not ideal but it works. The flow is something like this.
See notes on a page --> Identify letter name --> trigger muscle response to play note.
The opposite is likely true for some. If you have a good ear, or a well developed ear, then I think an ideal situation is to be able to hear the music in your head as you read it. Then the same muscle response is activated internally from your inner ear.
See notes on a page --> hear the phrase in your head --> trigger muscle response to play phrase.
There are a couple other factors to consider before making a definitive conclusion on this.
The brain is a complex system that we don't fully understand. It has been demonstrated that a single thought can "appear" in a FMRI in multiple places. So the idea that there are too many things happening and that slows down the response might be completely false! In fact it has been suggested that the more neural pathways that one can build for a certain action or response the faster and more stable that response will be. The brain likely parallel processes multiple patterns and turns them into an output response. That being said, identifying the letter AND the sound AND the shape may make for a better input to the decision gate that says "Move hand here and press these things". The signals do not sit in queue waiting to be processed (or at least that is what seems to be coming out of our understanding of consciousness based on FMRI).
To be a good sight reader you need to read ahead. You kind of have to be in two minds, two places at once. At least that is how I was taught by my violin and guitar teacher. I cannot say that this is the standard today but they got me to look at the notes several measures ahead while I was processing and playing the notes in a given measure. I think in a situation like this it helps to have multiple ways to process data. When I read I am able to hear the music in my head. This took time and practice. Many people cannot but that doesn't mean they are not good musicians or should give up. But that being said, as I read I am hearing what I need to play at the moment and buffering data that I will need in a few moments. That buffered data is (based on my experience) identified by something other than aural (e.g. a letter stream).
Letters and tones are not the only instructions provided in sheet music. Even if you could convince yourself that it's better to think less or identify fewer items the letters are the least of your worry. On an instrument like the guitar there are several ways to play the exact same thing. Well written arrangements will have position markers, fingerings, etc. That is instrument specific. On top of that are dynamic marks, accents, etc. Your brain needs to see and process all this to generate a model of the sound that should be produced. As someone suggested in another answer we know that the letters C, A, and T spell cat and we know what that word represents. Yet we don't consciously spell it out every time we see it. While I agree that this is probably true, we did spell it out (and sound it out) when we were learning to read and that may be an integral part of the process of being so good at reading that it becomes automatic. Finally, not all arrangements are that good and the musician needs to not only process the notes but decide from among several options which way to play it.
Putting more of a burden on your mind may be required too. As a guitarist I recall being trained to not only hear the notes I see, and identify them by letter, but to close my eyes and visualize geometrically how the phrase will be executed by my fingers. Over the years this has developed a physical response in my hands and arms to note streams I see. This is real hand eye coordination. I cannot say for certain that my brain is responding to the visual or the aural. It is probably responding to both and that is what makes it work well. You cannot dissect something this complex into a sequence of actions. One way to view this is as follows.
See note --> Hear note --> Identify note by name --> Identify geometry of the chord or phrase on your instrument --> determine correct muscle movement --> execute movement --> hear real sound --> match to expectation.
Clearly, if you think this is what is happening you will be inclined to reduce the number of things in this chain because you think each takes a millisecond or so. And they all add up. But what is really likely happening is this.
See note --> {Hear note in head, Id name, Id shape etc, Det Muscle movement} --> Move body --> hear real note --> match to expectation.
Everything in the brackets is triggered at once. And furthermore, I suspect that the greater the number of things in the brackets the better the reaction time is because so much of your brain is in agreement about what to do. Mastering an instrument and music does NOT involve finding the one thing that does not require training or practice. Mastery comes from integrating all the different ways of seeing the same thing and that speeds up the response, rather than slowing it, by building confidence in the output.
All my teachers used speaking the letter names out loud as a means to "sight read" and even though I did say I agree that one does not have time to do this, that assumes that the tasks are daisy chained together. As part of the learning process reading music like a newspaper or book does reinforce neural pathways that help in the overall process. They will have to get integrated into the brain for the effect to be observed but that usually doesn't take too long.
