First, for the majority of the population, I think that the typical delays are within a 1–3 year span. Your scenario would have a child who would typically be a 7th grader performing at the age of a 2nd grader.
If a child does not have special needs, but is just a slow learner, I think they would benefit from this levels based learning. Starting at the first level, the bell curve suggests that there will be some that advance quickly, many that advance at the traditional speed and some that stay at that first level for longer. But the number of kids who remain in that level will be a smaller population- and thus get more instruction, like a tutoring group. From my experience, kids that are capable of learning do really well when given this type of more personalized instruction.
Following this child, the next year would have a group of kids one age younger. Again, the bell curve will break out groups, but this time, having already learned the instruction, the hypothetical child is likely to be ahead of at least some of the new, struggling kids. Probably in the majority of the newcomers, so a 6 year old learning with 5 year olds. Over time, a typical child would likely be surrounded by a few age peers, some younger and some older kids, normalizing their spot.
If however, you are describing a special needs child, then just like the schools now, there needs to be special accommodations in place anyways. The special needs population isn’t typically expected to complete the curriculum, and the focus is on them learning more than the previous year. In this scenario, yes you might have a child of 12 at the functioning level of a 7 year old, but a child with that great of a learning difficulty isn’t likely to be mainstreamed anyways.
If we are talking about a child capable of learning, but at a slower pace, the levels system will actually allow for a lot more dignity. As schools currently are, these kids know why they are being pulled out constantly, they hear how much better their friends read, and they struggle over problems that their classmates blow through. Then they are given assessments they aren’t ready for, and fail, and feel worse about themselves.
Instead, in the levels system they would be surrounded by the kids who read like them, not pulled out all the time, and taught math at the level they are ready for. They would be more likely to get better grades at their level and feel good about their progress.
Which one sounds like more dignity to you?
Plus- if you are worried about what happens after elementary school, my guess, without looking it up, is that at a certain age they graduate to middle school. They will come into middle school from different levels… which is honestly what happens anyways. But it will be clearer to the middle school what their ability is when they start.