I just installed Eclipse 3.7 and the Google Plugin for Eclipse because I want to teach myself how to use Google App Engine.
When I create a new web application and run,
If you are getting that validation message, you should be able to find "Project Facets" under your project's properties. You should see a screen like this one, where you will be able to change Java facet version:
If you are not seeing this page, then the project you created is likely corrupted somehow. How did you create it? Did you use a wizard provided by Google Plugin for Eclipse? If so, you will need to file a bug report with Google as they are not creating a valid project.
Regardless of the above, you should be able to resolve this problem by right clicking on the problem in the problems view and selecting "quick fix", where you will be guided in aligning your java facet and java compliance settings.