E-Eyt!
I had the same problem myself after installing Xp, although not with GTA3 since i never played it on Pc, however with every game that requires directx 8 or above, i have a gainward geforce2 mx 64mb, which worked fine in win98, but not at all in Xp...
I also got the same problem when running dxdiag, the way to solve is to download directX panel, go to direct 3d and tick the "allow hardware acceleration" box, that should solve the problem, atleast it did for me, now everything runs fine so, hope that helped...
Seems to have something with geforce 2 mx and Xp to do, i know the Geforce 2 mx'es aren't fully Dx8 compatible, but really, stupid error... =/