YES! I figured it out! (Took a while...)
To get it to work you need to do several things. 1) Mark towns as settlements, 2) Set goods required to turn settlements into towns (technically optional), 3) Set settlement permissions (for the permits).

1) For each town in Scenario/Settlement/Town that you want to be a settlement, set TownActive to settlement. (When the town is founded it will ignore the starting population and factories. The population will be 500 and it will have no factories.)

2) On Scenario/Settlement/Goods, Right click and Add Child... and call it SettlementGoods0. Assign an amount and type. If you want to require multiple goods to found a city, then make another child called SettlementGoods1, then SettlementGoods2, etc. (You can skip this entire step, then when a settlement is founded it will automatically turn into a city after a slight delay.)

3) On Scenario/Settlement/Permissions, Right click and Add Child..., but be careful with this one—The Display Name should be _Permissions, but the Id should be _SettlementPermissions.

Once you have done that, you need to start filling in values. Required Citizens for Permission 00 should be 0. How this table works is if there are x cities active, then to get a permit for a new city it will reference the value for Required Citizens for Permission x. All active cities count, including those that were never settlements (but not counting settlements not yet founded). The population number required is the total population for all cities on the map. You must have at least as many entries on this table as there are cities on the map (both active and settlements).

So for example, Permission 00: 0, Permission 01: 30000, Permission 02: 60000, ... Permission 21: 630000.

Thanks for taking the time to answer this question in detail. At the time, a year ago, I did find a way around this by unpacking the data files with an unofficial tool and copying the relevant sections from the free mode base file. This worked correctly for what I was trying to do:
https://psteamcommunity.yuanyoumao.com/sharedfiles/filedetails/?id=2151399588&searchtext=

It's good to have this information though. There are potentially other uses for settlements. Especially for the Gold rush on the US West map. I did think about making a scenario of that. However, I didn't play the game much because of bugs. So wouldn't even be able to enjoy testing such a scenario. Also didn't really have time for it.

I play Trainiac and 1.14 introduced a bug while bulldozing: you can't make a selection with the tool. I bulldoze every few minutes. Just this week I have reverted to the legacy branch mainly because of said bug. This bug was reported within an hour of 1.14 release. It's been a few months, I have given up waiting for a fix. 1.13 has an introduced pathing bug that prevents me from using my preferred station/platform connection method. 1.14 did fix that bug. But I got to the point that the bulldozing bug seems worse.