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I used to read exclusively on my old iPhone 3GS, with its 3.5" 320x480 screen. It was passable. I now read on my HTC HD7S, with a 4.3" 480x800 screen and it's much better.
Honestly, though, screen size is less important than resolution. An iPhone 4 or newer will be better than a 3GS or older simply because it has a higher resolution, even though the screen size itself is exactly the same. Even so, at this point my phone size sweet spot is between 4.0 and 4.3". Anything less is too small. Anything larger is too big (the wife has a 4.5" Samsung Infuse, and those extra .2" over my phone make it just ridiculous).
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