dc42:
The schematic looks OK to me. However, most regulators will leak some current between input and output when you disconnect the ground wire.What is the current draw of the servo when you are not pulsing it? If it is very low, then there is no point in removing its supply. You could even use 2 or 3 silicon rectifier diodes in series to drop the voltage from 7V to 5V, instead of the regulator (saving the regulator ground pin current).
For micropower regulators, I like the MCP1702 series, which has just 2uA quiescent current and is available in a TO92 package.
No, you can't control a series-regulator by switching the sense pin like this - it doesn't work because you are not controlling the flow of current. You are simply fooling the regulator about the output voltage and making it turn into a short between input and output rails. The way a regulator works is by sensing the voltage between the output rail and the sense ("ground") pin and controlling a transistor that allows current to flow from input rail to output rail.
I suspect you need to use high-side switching on the input of the regulator for the servos, which will be awkward at 7V, or low-side switching before the regulator for the servos. In the latter case you'll need to add protection resistors (10k?) in series with the servo control pins to prevent damage to the Arduino input protection diodes).
Another approach is to find a series regulator with an enable-input.