Hierarchical Select is exactly for that purpose.
This module defines the "hierarchical_select" form element, which is a greatly enhanced way for letting the user select items in a hierarchy.
Hierarchical Select has the ability to save the entire lineage of a selection or only the "deepest" selection. You can configure it to force the user to make a selection as deep as possible in the tree, or allow the user to select an item anywhere in the tree. Levels can be labeled, you can configure limit the number of items that can be selected, configure a title for the dropbox, choose a site-wide animation delay, and so on. You can even create new items and levels through Hierarchical Select!