Okay so I pinged Dustin Campbell on the VS Team and here is his answer:
"To keep memory down, the output window ensures that there is no more than 256MB is taken up by the text in the output window. At 2 bytes per character, that means that no more than 134,217,728 characters can appear. However, that total is spread across all of the output window panes (e.g. “Debug”, “Build”, etc.). When the total amount of text used by each output pane reaches that maximum number, an algorithm is run to reduce the amount of text used by 10%.
Given that the maximum amount of text is already at ¼ GB, a facility to tweak that number was never added."
Makes sense from a performance standpoint IMHO.
Z