I have to second the thoughts of Momma11 as well. Something, that I know others have also mentioned, to keep in mind is that she is still ahead of her grade level. Just because she didn't advance more or "decreased" her reading level, I think you're failing to account for all the other stuff she's learned in the mean time. I mean, in K she was probably just coming in with the knowledge she had from you and any programs that she was attending. In the last 2.5 years she's also learned huge amounts in terms of math, writing, social studies, etc. There's only so much she can do at a time.
Secondly, and almost more importantly, is the fact that you have to understand that these reading tests are not 100% accurate. I don't know if they do a computer generated test or a teacher generated test, and that may be something to find out about. If it's a teacher generated test then you have to understand there is much more room for error. One teacher may not follow the guidelines and scoring exactly the way as someone else and could easily give the exact same test and come up with a different score/grade level. Also, has the testing process or actual test changed since she was in first grade to now? If so, you have to conisder a margin for error, or at least difference, there as well.
As many have already mentioned, find out about the gifted and talented program and go from there. If the school doesn't have one, then maybe you should look at either moving schools or moving districts, but before you do, see if there's anything you can do to implement one in her school, and I don't mean you necessarily have to run it or anything, but maybe they need parental support or people to write letters, etc.
I would continue to take her to the library and encourage reading at home. It's also great that she's taking those books to school so she can read them there too. I would talk to her teacher and see if there's anything that you can help her with that your daughter could do for in the class enrichment activities, because as Momma11 and others pointed out, it's not really fair to expect the teacher to plan a separate curriculum for each student. And, to the person who said schools just aren't what they used to be, I'd like to say that is partially because society is putting more and more responsibility on the school systems and less and less on the families. Also, in most average classrooms there are students all along the spectrum, and I can pretty much guarantee that there is someone in your daughter's third grade class who is reading on a Kindergarten level and their parents are expecting the exact same things from the school, principal and teacher that you are expecting.
Lastly, I would like to just say that if you do choose to move her to a different school next year, meet with the staff beforehand and make sure that your needs will truly be met there before deciding on the change.