To be fair, at least "that is retarted" actually kind of makes sense as retarted means slow or of disability or handicap and it is usually used to describe "stupid, slow, and illogical" things. EXA: "My teacher in math class have us three packets to finish by tommorow. She is so retarted" In this sense the kid is just replacing the word "stupid" with "retarted". Pretty much just giving a stronger version of the word that can be offensive and people are more sensitive about.

While I am not condoning it, I can understand why we as people use that word rather than the gay slurs.

Gay slurs are often used on nearly everything that has not to do with the homosexual world and are usually just used to degrade a regular person or as a typical immature insult.