They should do that with sports too, since it's fair and provides a reasonable basis for comparison
The biggest red flag here for me is not that the tiny elite remain, it's that life circumstances will dictate that the majority of the tiny elite will continue to come from privileged families who have the time and resources to give their kids a leg up. BUT pushing kids into places where they objectively cannot compete intellectually or physically under the auspices of fairness is the devil's work. We need constant work at creating equality and to lower barriers to social services, not "fairness" and pretending everyone is already equal.
This idea that school is a place where kids compete with one another, the weak are weeded out and the strong are rewarded with additional resources is a disgusting perversion of an institution we used to recognize as providing a baseline for everyone. And it simply doesn't work.
Failing to teach kids how to read is a failure of the school system, not the kid.
Dropping kids because the school system failed them is just yet another failure of a school system, and one which is at best a self-serving failure: a way to mask the extent of which the system is broken by blaming the victims of said system.
As an exercise, invest a few minutes thinking on why most communities do not experience this failure rate.
That's besides the point, and orthogonal to the discussion. If after 3 years a school system failed to teach kids how to read, that represents a failure of the school system. If a school system feels the need to hold kids back so early in hopes that subjecting them yet again to the same school system that already failed them will somehow improve outcomes, this means the same school system is not investing in fixing the real problem.
This is like buying bad tires. If a tire blows up, you can argue all you want that changing the tire is much better than keeping a flat tire on. But the root cause is that the tire blows up, isn't it? Changing a bad tire with yet another bad tire won't fix the problem, will it? The tire you just added will easily blow up again, and everyone else buying those tires will go through the same problem.
I repeat, advocating for holding kids back and even rejecting underperforming kids from the school system is a Hallmark of a deeply broken, unsalvageable system. The only purpose of these approaches is to falsify the actual quality of the work performed by the school system, and generating fraudulent statistics of success at the expense of throwing kids under the bus.
For the same reason, they mostly got rid of "tracks," where an age group would be divided into different classrooms according to test scores and previous grades rather than random chance, so the 'A' fourth grade room could go at a different pace from the 'B' fourth grade room. All that's left of that is gifted programs, which people somehow accept even though they're just the mirror image of holding kids back.
There's really not a good answer, because like it or not, learning ability varies, so if you put 25 kids in the same classroom for no reason other than their being the same age and living in the same neighborhood, some are going to struggle and fail and some are going to cruise and be bored.