Basically, flash would allow people to set up iPhone-sized web sites running flash games or other programs that would compete with the app store.
Right now Apple has control over what goes on the phone. No xxx apps. No baby shaking apps. Etc. Allowing flash would whisk that control away from them overnight.
Yes, I know you can get any kind of content on web sites...but they're not interactive programs like flash could deliver. They're not games (which is the biggest part of the app store).
So adding flash adds a bunch of problems for Apple.
And what's the downside? Well, not much. I've seen a TON of sites change over the last 2 years from being flash to using things like AJAX and Java. Or at the very least, they've added an iPhone version. (And anyone with a great flash game went and started making iPhone apps...which Apple controls.)
In other words, the iPhone won...the web is changing to fit the iPhone!
So at this point, what incentive does Apple have to change? They would risk losing control and have very little to gain in exchange.
Doesn't matter. Even if Adobe came up with an efficient, non battery-hogging flash, all the above reasons still stand. Apple just isn't interested. They say "bad battery life" now because it's an easy excuse. But watch...even if that changes, Apple won't change their mind.