I think it's pretty clear from your post that you don't really understand why your wife is doing this. Personally I don't either; everyone I knew did hand me downs to some extent, including passing things to friends when their own kids outgrew them, as long as the clothes were still decent. But I think if you want to change her mind/solve the problem, you at least need to know what you're changing it about.
Are you low on (storage) space, so keeping extra things for a year makes it feel cluttered? Then coming up with a storage solution would help.
Does she associate all hand-me-downs with being "ragged" automatically (kind of like some people refuse to eat leftovers, wtf)? In that case, focusing on the merits of each item might help. I did like the point made that some of the items might have not worked out as expected; but that shouldn't be the case for *all* clothes going out...
Is she concerned about style/fashion of the clothes? This could be a concern that the kids will be made fun of for their clothes, but more likely a form of self-projection ("I am the type of person with kids that are dressed like this: ") Not sure what can affect this mindset. Perhaps looking back at how much kids fashions change in 1 year, especially with respect to basics (not a hell of a lot...)?
This might be purchasing driven; i.e. she enjoys buying the clothes and doesn't want to save hand-me-downs because then she doesn't get to. Could be justified as the ragged/fashion-conscious argument above but not the underlying cause... Also not sure how to change someone's mind on this. Might go hand in hand with the overall investment in an MMM/frugal lifestyle.
Final note: if you want to change how the children's clothes are handled, you might have to actually, physically get involved in the sorting process, because "backseat driving" on any task is a shortcut to aggravation. Example: I get annoyed very quickly when bf complains about how I stack/soak dishes in the sink(s), when I wash 95% of dishes (no dishwasher). It literally does not bother me at all when the sinks are full of dishes; it bothers me a lot more when the counters are full of dishes and we can't cook. So, while I do almost all of the work, I'll do it my way; if he did more of it, I'd be more amenable to his opinions. (Note: he handles 95% of trash so that's a pretty fair trade. And I don't tell him how to tie the bags.)