The hydraulic limitation hypothesis proposes that (1) reduced growth in taller trees is caused by decreased photosynthesis resulting from a decrease in hydraulic conductance promoted by a longer root-to-leaf flow path, and (2) this mechanism reduces stand productivity after canopy closure. This hypothesis was tested by comparing the physiology of 7 m (1 year) and 26 m (5 year) Eucalyptus saligna plantations where above-ground productivity for the 26 m trees was approximately 69% of that for the 7 m trees, and water and nutrients were not limiting. The study compared whole tree physiology [water flux (Ql), average crown conductance (GT), crown hydraulic conductance per unit leaf area (KL), carbon isotope discrimination (δ13C)] and leaf physiology under light saturation (leaf water potential at the canopy top (ΨLEAF), photosynthetic capacity (Amax), and photosynthesis (A) and stomatal conductance (gs). KL was 50% lower in the taller trees, but whole tree Ql and GT were the same for the 7 m and 26 m trees. Photosynthetic capacity was the same for leaves at the canopy top, but δ13C was −1.8‰ lower for the 26 m trees. A and gs were either lower in the taller trees or equal, depending on sampling date. The taller trees maintained 0.8 MPa lower ΨLEAF during the day and had 2.6-times higher sapwood area per unit leaf area; these factors compensated for the effects of increased height and gravitational potential in the taller trees to maintain higher GT. The hydraulic limitation hypothesis (as originally stated) failed to explain the sharp decline in net primary productivity after canopy closure in this study. The effects of increased height appear to be a universal hydraulic problem for trees, but compensation mitigated these effects and maintained Ql and GT in the present study. Compensation may induce other problems (such as lower ΨLEAF or higher respiratory costs) that could reduce carbon gain or shift carbon allocation, and future studies of hydraulic limitation should consider compensation and associated carbon costs. In this study, the combination of similar GT and lower δ13C for the 26 m trees suggests that total crown photosynthesis was lower for the 26 m trees, perhaps a result of the lower ΨLEAF.