It's a major problem. iOS 8 demands something like 5GB of free space. The existing OS takes up maybe 4GB, so on your 16GB device, you can't upgrade if you're using more than 7GB or so. Not even half!
It's still possible to upgrade using a computer, but how many people even know you can do that anymore? The days of syncing with iTunes are long gone.
I know why they keep offering 16GB devices as the baseline (easy upsell), but it's got to be a lousy user experience for people who do buy them. Just installing iWork and GarageBand will eat up a huge chunk of that.
You'd think that by now the poor user experience would trump the extra profit. Apple's reputation is built on "it just works", and 16GB of storage is starting to fail that all by itself.
It's still possible to upgrade using a computer, but how many people even know you can do that anymore? The days of syncing with iTunes are long gone.