This toy was made for a 3rd year birthday of my son.
It is simple to make, but a lot of not-so-fun work: a lot of cross cutting and even more drilling.

It was made from a 4" Pre planed white pine Timber.
Eventually i found that it was to early for a three years old boy, even though he is a big for his age.

Bill of Materials:

4" Pre-Planed White Pine (as much as you'll able to work on)
1" Dwell for the Pegs (I've made it from a wood broom stick - again, as much as you can handle)
Non toxic Paint for toys - multiple colors

For that you'll need a (tools list):

Miter saw (Motor powered one, please!!!)
Drillpress
Small hand sander
a brush (prefferbly pneumatic one, as it is a lot of ground to cover)
and some hand tools (angle, ruler, pen, etc.)

Step 1: Proof of Concept

Before i've stated going crazy with a lot of cutting and drilling i wanted to know that it could work, and could hold it self with the wooden pegs, so i've made three blocks from different sizes, and played a little bit with them.

the PoC was O.K. but some how i didn't thought about the weight of the big blocks a head of me.

Step 2: Cross Cutting

So the Cutting is somewhat straight forward, and it's rather simple so i won't spend a lot of time on this topic, but i'll do point a couple of things:

Remember that the Miter-saw blade has thickness so you'll probably need to measure each block right after the last cut was made. it's a pain but with simple tools it's the only way if you want to get pretty same-size blocks.
Because i wanted the first block to be square, it forced me to use this set of sizes (it's in cm): 9, 13.5, 18, 22.5, 27, 31.5, 35, 38.5 and the biggest (of mine) that was 43 cm. those sizes was driven from my imagination, you can do what ever you like as long as you're consistent with your choice.
Measure twice - cut once (or "Better safe than sorry" - but that probably is right for every instructable there is)

Step 3: Marking Holes

It may seem a small and insignificant step, but this makes all the difference. If you're holes is not align with each other, the stability of the structures will be compromised and it will be less fun and, more important maybe, less safe to play with.

the holes need to bee aligned and drilled accurately as possible, especially if you are hand drill-press and you don't have a mill with an accuracy table or something like that.

Step 4: (A Lot Of) Drilling

After marking, Drilling is the most time consuming activity in this Instructable.

Remember to have your drill bit occasionally Sharpened as it will get dull with time. I calculated over 1000 holes to drill in my not so big of a pile of blocks, so be afraid... be very afraid.

Also, know that for soft wood you'll get a chippy hole in one axis (against the grain) but with harder wood you'll pay a fine of speed and wear of equipment.

Step 5: Sanding and Cleaning

I've used a very simple eccentric sander, because in that time, it was the best tool i've have to clean the blocks.

because the timber was pre-planed there was'nt a lot of sanding involved. but some, where the cross cut found a weak spot and broke the grain.

Cleaning the holed was made with a hand drill with a round sanding bit that was just a bit smaller then the holes.

Step 6: Making the Pegs

As I mentioned before, i've bought a wooden broomstick that is common in hardware stores in my area, cut it to almost two times the hole's depth, and sanded the edges for ease of use.

Step 7: Painting

Forgot to take pictures of this stage, but you're getting it, right...?

bought toys non-toxic proven paint in yellow, red, green, blue, white and black, and made some mixed to get to different colors i didn't had. Just remember, if you're mixing colors, to make enough paint for the hole batch, otherwise you'll have hard times to create the same tone in the middle of the stock.

Step 8: 1-2-3 Build!

After it dried out you'll probably spend an evening carring blocks from the workshop to you're child room while he is a sleep. In the morning it will all be worth it! my kid asked me a real train for his birthday, so i've build this locomotive from the wooden big blocks for him to wake up to it in the morning.

You can imagine our mutual joy while exploring the possibilities in the morning.

Cheers.