It's not that big
a deal for myself or another network admin to add new employees or
remove them when they leave.

Do you mean that you're creating a separate folder of contacts that duplicate the employee list that is already in the GAL? That sounds like a lot of duplication. DLs of employees should be maintained in the GAL where the original data is. If your host provider can't handle that, I bet there are others who can.

If I tell our
users that each time they need to send an email to a particular group,
they will need to go into contacts and select each person in the list
or they need to maintain their own lists I can assure you that I will
soon be out of a job.

I suggested neither. Categories make it easy to select an entire group of people from a shared contacts folder.

As for mail merge, well, where is the list supposed to come from and
who maintains it?

Same place as it is now - a shared contacts folder, or better yet, a public contacts folder, which doesn't have the same limitation related to the address book.
--
Sue Mosher, Outlook MVP
Author of Configuring Microsoft Outlook 2003
http://www.turtleflock.com/olconfig/index.htm
and Microsoft Outlook Programming - Jumpstart for
Administrators, Power Users, and Developers
http://www.outlookcode.com/jumpstart.aspx