It was a level coined by the head developer of the 2011 Sonic CD version Christian Whitehead, who posted the information about Desert Dazzle. According to him, this level was cut so the game didn't stray too far from its original form. However, an image of it is still featured in-game.
It was revealed that the Sonic CD levels were sorted in a folder and went through R1 (Palmtree Panic) to R8 (Metallic Madness). However, R2 was scrapped and R1 went straight to R3. Desert Dazzle was confirmed to be the replacement for R2.
It should be noted that when you look at the Little Planet in D.A. Garden or on the 1996 PC version's loading screen, you'll notice that there is a desert area with a single cactus. This is most likely the main reason Desert Dazzle was created since there is no other level that features this area (with the exception of Wacky Workbench's past, which shows that the factory was built in a desert-like area).
Level assets intended for use in Desert Dazzle (background, land tiles, and objects) have been incorporated into Sonic Mania's Mirage Saloon Zone.