Is this level of rusting removable by sandblasting? Is this rusted steel frame still salvageable? The local bicycle shop does sandblasting before they powdercoat a frame. Do you think the sandblasting alone would be enough to remove the rust? 

I'm aware that all traces of rust must be removed, or the corrosion will continue under the new layer of paint. I'm just not sure if it would be possible in this case.
Any amount of rust is removable by sandblasting or chemical means. That's not the problem here though, the real concern is how much frame material have you got left after the rust is removed. The top tube walls may be too thin for the frame to have structural integrity. Remember the steel may be rusted on the inside too, and there may be rust 'pits' that go all the way through.

If enough frame material remains, it looks like you'll have to fill and sand the top tube smooth  otherwise it will look horrible when painted

I think at this stage you have to ask yourself if all this work is worth the time and money. If the frame is a rare, classic or means a lot to you it may be worth restoring,  but would it cost less to just by another used bike?