Honestly, if I didn't care so much about my grandfathered unlimited data plan that I have on Verizon, I'd have ditched my smartphone last year, gone back to a dumb-phone and have gotten a second generation iPad mini with cellular and a decent data plan. I'd have done that and called it a day. Cellular on the iPad isn't anywhere near the rape it is on phones. It just isn't. And honestly, that's what makes all the difference in the world when comparing the prospect of owning an iPhone to the prospect of owning an iPod touch instead. Otherwise, I'd stash my fifth generation iPod touches where I keep all of the other tech gadgets that I own, don't use and am too sentimental about to get rid of and I'd be looking into a 64GB iPhone 5s to replace it with (sans a cell plan if need really be).
Cellular is what makes all the difference in the world. Both in terms of importance and, more importantly, in terms of price.
These days kids are given phones as soon as they start elementary school. It makes sense. Why give them a dumb phone and an iPod touch, when an iPhone, for them serves both needs. That is a consolidation that I can understand. Otherwise, if the iPhone is not to be used as a phone, it's almost too expensive to use as an iPod touch. It's much unlike Android where there are tons of decent phones that you can buy out of contract and use without a plan in iPod touch fashion. I may just switch to the combination of an iPhone Plus and an out of contract Android phone without a plan used as an iPod touch from my current combo of an Android phone and aging iPod touches.
I don't think the cannibalization is in the iPad, but rather the iPhone and the tendency to listen to music via streaming services that require constant data anyway. The idea of local storage playback devices as a primary means of playing music seems to be becoming increasingly uncommon. I don't think many people store the bulk of their music on their phone's storage; I think they use iTunes Match, Google Music, Spotify, Beats Music, Pandora, iTunes Radio, and anything similar to or in between that range of services instead, in which case a wi-fi only device is impractical. The only reason why I think the Wi-Fi only model iPads make sense where the iPod touch is starting to not (and it hurts me to even say that the iPod touches are starting to not make sense) is in that there are more tasks that are superior on a tablet form factor than on a phone that don't necessarily require constant connection.
To be fair, when it comes to pricing and how easy it is to buy one versus the other, that is the only difference that really matters. If iPhones were priced identically to iPod touches for OUT OF CONTRACT pricing, then there really would be no reason for the iPod touch to exist as it would be functionally redundant if not deficient in every possible way.