...We pretty much do the same thing. Players who lose their characters start with a new one a level behind the average party level. They also get new gear at the norm for their new level, after being approved by the DM.
...If your group has a long standing houserule, that the majority stands behind, then stick with it. Caving into a whiny, selfish player will only encourage that person to do it more in the future whenever they don't get their way.
I'm not sure why we feel the player needs to be "penalized" more for having a character die. "I just can't make a Paladin work in this game" seems a lot less in-game dramatic and fun than "and the bold Paladin remained behind to guard the bridge, giving his own life that his comrades at arms might escape to fight another day". "This character isn't powerful enough so I'm going to retire him and bring in something more optimized" also doesn't strike me as great for the game.
However, Raise Dead would cost the character a level, so it seems fair the new character would be down a level. In Pathfinder, the negative levels bestowed by Raise Dead can be restored, so I would have a different view there (maybe he should be WBL-light by the cost of the Restoration spells), and pe-3e, I recall being Raised reduced CON, not levels, so that's a different ballpark as well.
I'm not sure why we feel the player needs to be "penalized" more for having a character die. "I just can't make a Paladin work in this game" seems a lot less in-game dramatic and fun than "and the bold Paladin remained behind to guard the bridge, giving his own life that his comrades at arms might escape to fight another day". "This character isn't powerful enough so I'm going to retire him and bring in something more optimized" also doesn't strike me as great for the game.
...I think it's less of trying to penalize players and more of a throwback to the old idea that death should have some sort of consequence. Having also DM'd and played with some folks who like to show up with a new pc at every session anyways, it helps cut down on the madness.