It should be possible to increase that value by adding an upload_size parameter to your site’s app.yml file. See Change the maximum attachment/upload size for details.
I changed max image size kb to 500k and it uploaded, I wonder though if the error message shown to users should simply be something like “Upload failed: image size too large, please resize and try again”?
I can’t remember for sure now, but IIRC if you lower that setting and an uploaded image is larger than that, Discourse will attempt to resize the image to bring it down.
I think it’s tied to the png to jpg quality setting? It was a while ago now but I think Sam worked on the image resizer.
With regards to anyone who’d want to change it (or rather want smaller image sizes) I’d imagine any site where image quality is less important (so most sites apart from photography sites).
Quick search returned this - so looks like the resizer hasn’t been implemented yet (but I was sure it had )