The following text is excerpted from Andrew Linden's response to a flight height limit question in the old Linden Answers forum, on 10-12-2006. The original text can be found here.
The height limit for flying was a social engineering design decision from way back in the beginning of development of the project that eventually was called 'Second Life'. Another part of the design from around the same time was a stipend/tax economy where high altitude objects were taxed differently. The reasoning behind these height/limited features was to help keep the limited number of primitives in each region down near the ground, thereby increasing the avatar-content and avatar-avatar interaction. At the time it was not clear how compelling the SL virtual space would be, and whether people would need coaxing in order to interact with each other.
Another feature related to these social engineering ideals was limited teleportation (no arbitrary point to point teleports). At first teleports cost L$ by distance travelled, then later the 'telehubs' were added such that you would arrive at the nearest telehub to your destination, and you would have to manually fly the rest of the way.
Today there are no taxes, stipends are largely gone, restricted telports are now only a special feature of some private estates, and parcel access rights have been bumped up much higher than they were... which is why avatar flight limits were bumped up from only 100 meters above the ground. As SL becomes more and more of a platform and tool the arbitrary limitations of its design make less sense.
No one Linden is going to make the decision to remove flight heights, but if you get enough of them into a consensus then a feature like that could be nerfed. I'd recommend either getting a big pile of protestors and making yourself heard, or finding a kindred Linden who really wants to push that feature change through the system. But first, ask your fellow SL Residents and gauge their opinions as to what the flight limitations should be, if any.
There is a technical reason for not allowing arbitrarily high builds relating to initial balances of the physics engine settings. Right now the build limit is 768 meters. Above that physical collisions don't have the same resolution or correctness.