The arm adjustment is supposed to locate the dead pad just off the disc, 1/4-1/2 turn back from where there's drag. This is a bit tricky with the locking nut as tightening it changes the adjustment - but it's not impossible.
The two things that usually cause this problem of piston non-retraction are corrosion in the seal groove and air in the system.
Corrosion causes increased friction at the seal. Air frustrates the pull-back suction from the master cylinder.
When you pull the brake lever, the first fraction of movement just blows fluid back to the reservoir through the relief hole. Once the hole is covered by the piston you are pumping fluid into the brake line, pressurizing the system. If the caliper is working properly and there are no air bubbles, the caliper piston slides freely out until the disc is getting squeezed - after that the brake applies proportional to the pressure.
Then you release the lever.
The seal distorts slightly under pressure. When the pressure is released the seal relaxes, pulling the piston back a hair. Once the m/c piston has released pressure it moves back to where the relief hole is uncovered again. In that movement it produces a suction. This suction moves the caliper piston back to where it was before brake application, off the disc. The arm spring relocates the caliper so the dead pad is clear.
With air in the lines, on brake application it gets compressed and the bubbles shrink until the pressure is high enough to move the caliper piston. Actual braking power is unaffected, lever travel increases and if extreme the brakes will e barely on with the lever against the bar.
The problem is that the compressed air bubbles expand again as the lever is releases, meaning the fluid is under pressure from them rather than under suction when the caliper piston is returning to the relief hole. That means the caliper pad does not retract. The brake never releases fully until riding vibration rattles the caliper around enough to bounce it free. There's no real resistance to m/c piston retraction, fluid can go through the relief hole. A corroded seal groove makes it harder to move, though.
If the relief hole is truly plugged, the situation is similar but can get very serious - the brake is left slightly dragging and heats up, the heat expands the fluid, the brake gets tighter and hotter, and eventually you have heavy braking applied and a red hot disc if you don't notice it happening and stop. Hitting a slippery bit of road with the brake dragging severely gets quite nasty.