The really key argument that hasn't been addressed here is why does such a behavior belong in psql, rather than elsewhere? Surely legibility problems aren't unique to psql users. Moreover, there are exactly parallel facilities for other datatypes on the server side: think DateStyle or bytea_output. So if you were trying to follow precedent rather than invent a kluge, you'd have submitted a patch to create a GUC that changes the output of boolout().
I find Tom's analogy to datestyle and bytea_output convincing.
+1 for a GUC that changes the behaviour of boolout.
-1 for changing boolout(). It will break anything that receives boolean values from the server. How a client is going to display values (of any type) is logic that should belong in the client, not in the protocol.
This is not fully valid, because transformation from binary to text is processed on server side. And client side transformation is easy only for scalar values.
