This is a new feature of Mac OS 8.5. It is called a "proxy icon". It allows you to manipulate the folder whose window you are viewing, without having to close the window or change the window you are looking at.
Figure 1: Mac OS 8.5 Finder window with icon in title bar.
You can use this icon to:
- Move the folder to the desktop, trash or another drive or window.
- Make an alias of the folder. (using the command-option keys while dragging)
- Duplicate the folder. (using the option key while dragging).
There is no way to disable this feature in Mac OS 8.5.