Ok, I signed up just to post this, so I hope people listen
I personally think this is an interesting idea, and if implemented well, it could make a riveting story-based game. As everyone so far has agreed, it would be difficult to include in an MMO, but a story-based RPG would be the perfect medium. The biggest problem here is that people keep thinking on the lines of other stories, rather than one built around this mechanic/
Think of something like this. You start as a powerful wizard/witch, revered, feared and held in awe around the land. But when a dark force invades the land, wiping out towns and cities, the people call on you to save them. The first few missions have you completely wiping out legions of enemy forces, until you meet the first boss, also a person of magic. On defeating him, you are cursed with a terrible malady that constantly drains your lifeforce.
But it's not your life that is weakened; instead you are forced to heal yourself with magic, something that decreases your powers progressively. This wouldn't happen constantly, and tiny level 1 enemies or sidequests would not affect this. Instead, taking the gated approach, every time the player defeats a pivotal boss, at the cost of great magic, he becomes weaker.
As the game progresses, you would be required to take each engagement differently, making you think tactically and treating some battles like puzzles. Say you need to get a key from the top of a tower. You could either blaze through the tower loaded on health potions and the like, killing everything in your way at great monetary cost, or you could climb up sections of the tower to circumvent whole battles. Or, my favourite part, you use what powers you have an use the environment around you to defeat opponents.
Boss battles would become like puzzles, you using your powers to blow up explosives, or cause objects to fall on them. You could still take the run-and-gun approach, but this approach becomes harder and harder as the game progresses, punishing the player for not evolving with the game.
See, with this mechanic, you would not necessarily select abilities to lose, but instead the abilities you do have become weaker, giving players enough options to prevent the button combos becoming stale. As the final boss fight comes around, it will be almost impossible to fight it conventionally, so instead the player has to do it smart. In my mind, this results in the hero expending too much power, with the effect that curse eventually kills him, a sacrifice made for the people who feared him. In my mind, this would give players a great sense of accomplishment that the last boss WAS hard and they defeated him in the ultimate sacrifice.
So, please, if you're going to knock this idea, then don't do so by saying "But it would suck if such-&-such game implemented it," instead think of an idea built around this concept.
OR if people are wishing it to be implemented in a multiplayer game, think of it in comparison to CoD instead of WoW. Players start out with the most powerful weapons and perks, but as they level up, they are forced to use less powerful weapons and less effective perks. However, good players would still be able to stomp on bad players despite this handicap.