Prior to Mac OS 7.6, the Installer just silently reverted and left it up to the user to notice that the Clean Install button had changed to Install. For Mac OS 7.6, Apple decided to alert the user to this change by presenting the alert you see.
The easiest way to enable the clean installation option again is to click Options in the Installer application (not the "Install Mac OS 8" application), and choose Install New System Folder. If the Installer is quit and then restarted, using the "Install Mac OS 8" application, the clean installation option will be enabled once again.