1-2" is going to be tough! An MR16 bulb alone is almost 2" tall, and oyu still have to deal with the socket and housing. Ahat is above the ceiling? If it's combustible, you'll need an IC unit, or have to maintain 3" clearance.
Would a "puck" type light work for you? It's not recessed, but is small. I'd use a honeycomb filter on it to reduce glare.
The other option I can think of is Fiber Optics. They certainly would work with your size limitations, at increased costs though. Try: http://www.visual-lighting.com www.fiberstars.com
Here's a few links to get you started with small electric fixures: www.luciferlighting.com www.bklighting.com www.seagulllighting.com
Let us know a more detailed description of your application, and we may be able to help more.