They see it smeared all over your character's face. Om nom nom
But seriously, good question. It hadn't occurred to me, since I generally just dump the stuff in a pile in my player house and forget about it. A mod that adds more depth to moon sugar would make sense, but I think what is in place was probably Bethesda's simple fix to prevent you from selling it to the vendors who would not partake in that trade. A lot of Morrowind's dialogue was awkward, like the repetitious rumors and hits or whatnot, but with a lot of mods fixing that stuff, the moon sugar greeting seems to stand out a lot more.
If anything, a fix having the vendor detect the presence of the moon sugar
in the room would be half a fix. Perhaps it has a strong odor and it's obvious you are carrying it, but at least making it so that you have to dump it outside would make that more believable. So detecting it in the room and changing the dialogue to "
You'll Have To Get Rid Of That Moon Sugar That I Smell..." would fix the problem.