Why would Itch pay the fees out of their own pocket to send you money, instead of paypal or Itch deducting those fees from the sent amount?

Also, maybe doublecheck on that 4.99. Is that a capping for a percentage or is that a flat fee?

As far as I remember, a paypal account does not need to convert currency, unless it is a currency it cannot handle at all. So if you get paid in dollars, there are now dollars on your paypal account. You only need to convert it, if you send it somewhere that cannot accept dollars.

Similar for paying. If you pay in dollars and paypal cannot retrieve the money from your connected accounts or balance in dollars, conversion needs to happen. Paypal will of course happily offer you the conversion, even if the connected account could do it. So better check on which end the conversion will have lower fees.

You must pay all the fees that PayPal charges i.e. it will be deducted from your earnings. There are two fees, the first is a fee on processing the payment when someone buys your game or asset. The second is the fee for processing the payment when Itch.io pays you.

You could spend the money from your PayPal account - i.e. use it to buy something else. In which case you don't have to link a bank account to it.

Itch.io uses US dollar, so if PayPal allows you to hold funds in US dollar, you don't have to convert it. If they don't - they will convert it and you'll pay a conversion fee which is normally built into the conversion rate.

If you bank it, and your bank account is in a different currency then either PayPal or your bank must convert it. And that will depend on the arrangement your bank has with PayPal.