Windows system icons are currently limited to a maximum size of 72 pixels (inside the explorer shell), therefore IconPackager is unable to utilize larger sizes for the system icons.

You can use other programs (IconX, ObjectDock, DesktopX, etc.) to display desktop icons at larger sizes, but nothing inside the explorer shell.

Windows Vista will allow use of larger sizes, though I do not know the actual limit for the explorer shell yet - perhaps someone else will know if Vista will allow the full 256 pixel size to be applied inside the shell and not just on the desktop.

Standard ".ico" files created for Windows XP include sizes from 16 to 128 pixels.

Windows XP can support up to 128 pixels, though I have only seen 72 offered in the Display Properties > "Appearance tab > Advanced button > Item > Icon" dialog - which will change the Start Menu panel icons to that size.

Default sizes in XP are the 16 pixels for taskbar buttons, titlebars and All Programs icons, 32 pixels for Start Menu panel and special panes, and 48 pixels for icons in Tile view.

The larger sizes in the ".ico" files can be used in the third-party programs that can display those sizes independently of the explorer shell limitations.

So, yes - the desktop is the location for using the larger image sizes.