There are several reasons and solutions, first, call AT&T Business Services
(Premier) and complain politly, they may either ship you one, or call the
local corp stores and tell them to sell it to you.  Second, the jerkoffs at
the local store make no commision on the sale of a hot item.  So these
guys/gals don't want to sell it to you, but rather a new customer or
eligable customer.  At the worse they should have sold it at an unsubsidized
price, at the best, they should allow an upgrade.

I've had issues with a local store in the past, after I was told to go and
get to added phones for my daughters, they wanted my to toss medianet on
them, and I didn't want to.  I called 611, from my phone, they called
another story which was also close and in 5 mins had them up and running.
Some guy I knew worked at the store told me the manager and salesperson was
pissed because they basically got reamed out by corporate.  I like you have
an expensive plan.

My only problems with an iphone sale was at an AppleStore do to my FAN, I
just gave up and walked out,  went to an AT&T store they ordered one, had it
like in two days, and no problem.

So Oxford whouldn't sell the guy the phone?  Imagine that.

UPDATE #3: I finally got through to AT&T's national customer service
number, then waited on hold for about 20 minutes while they tried to
get through to the local store. It turns out that store management in
Santa Barbara was confused about the policy, and that my wife is in
fact eligible to purchase iPhones at the normal prices, plus a $200
penalty for being an existing, loyal AT&T customer.

Final thoughts:

This whole episode has eroded my confidence in AT&T and Apple. Here's
what they got wrong:

AT&T store management failed to learn basic details about their own
upgrade policy, and told a customer (and probably many others) that
she was ineligible for an iPhone upgrade at any price; that other
stores would tell her the same thing; and that it was uncertain
whether she would be eligible to upgrade to an iPhone even when the
account became eligible for upgrades in general.
It's foolish to nickle-and-dime a $4,000-per-year customer, especially
when that customer is trying to upgrade to a much more expensive data
plan.
It took me two hours to get anyone from AT&T on the phone.
When I did call, they made me give my phone number three times.
Because my wife's BlackBerry is malfunctioning, she's eligible to
upgrade to absolutely any phone immediately -- except the iPhone. Why
the iPhone exceptionalism? Why doesn't Apple make sure their product
isn't taken off the table when an AT&T customer wants to make a
conversion?
Apple and/or AT&T act like everyone is a rabid fanboy. But many
people, like my wife, are current Windows and BlackBerry users who are
merely toying with the idea of becoming Apple customers. When these
fence-sitters finally muster up the interest to go give an Apple
product a try, and are met with resistance, incompetence and something
that feels like Apple snobbery, much more is being lost than a single
iPhone purchase. My wife needs a new laptop, too, and might have loved
the iPhone and made a total, lifelong conversion to iPhone, and Macs,
too. Now she's got a broken phone and needs to upgrade and will
probably just get another BlackBerry because she harbors ill will
toward Apple. We're also now thinking about switching carriers. We'll
have to file this one in the "FAIL" category.