I think that students should be given a selection of work ranging from easy to challenging and encouraged to choose the most demanding work they can. After a few iterations to allow the teacher to gently nudge kids toward their optimal difficulty, the students are evaluated based on their proficiency and chosen difficulty. This process should be repeated throughout their education to compensate for "late bloomers."

The terminology used to communicate to the students may have to be altered so as to prevent students from feeling obligated to choose a higher difficulty than they should, such as saying "choose the kind of work you find most enjoyable and least boring," so it sounds like a horizontal rather than vertical separation.