Yes, you are correct, you can purchase up to $5000 of paper I bonds with your tax refund and that is in addition to your electronic bonds purchase.
I assumed that since you can't purchase paper I bonds any other way now, that would effectively eliminate the $5000 limit.
As far as why your Form 8888 election was not processed, I found this on the Treasury direct website:
"If the IRS encounters errors on a return (refund amount is calculated incorrectly, IRS Form 8888 is completed incorrectly, requested amount is not a multiple of $50, etc.), the bond purchase will be cancelled and the full refund amount (if any) will be delivered to you."
I am not sure why you didn't get your bonds, but Treasury Direct says to call 844-284-2676 if your refund was processed and you didn't get your bonds.
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