I think what tends to break the game (or did particularly in 3E) is not the level inputs but the enhancement bonuses. When you add magic armor, a ring of protection, a DEX boost, an amulet of natural armor, etc, to AC and they all stack, the math breaks pretty quickly (across all scores, generally except HP). To make the system work we either need to eliminate enhancements, or keep them to a reasonable number. Perhaps no stacking at all (only the best enhancement that improves AC counts, for example), or limit stacking to a total -- no more than +5 can be applied to any score or roll from any enhancements.
It's a very tough question.
Magic items introduce a lot of chaos into any system. In all versions of D&D that I can recall, if the PCs didn't eventually get magic items, they were screwed. And players like magic items.
So, one possible solution might be as follows:
You design the mathematical framework of the game such that the PCs and NPCs are using the same basic math, but the NPCs might be one level below the curve (i.e. 4th level NPCs fight as 3rd level PCs) in some way. In other words, the NPCs might have a slightly harder chance to hit and might be hit a bit easier, but they might have some extra hit points and do a bit more damage than the average PC (this is the 4E model, there are other options, but typically, monsters of the same level are a little bit weaker than the PCs).
Once you determine the mathematical framework, you limit your magical items.
In 1E and 2E, there were +4 and +5 weapons, but I saw very few DMs hand them out. DMs who handed out a Sword of Sharpness or a Vorpal blade tended to regret it sooner or later. The vast majority of weapons handed out were +1, there were some +1 but +x in a specific situation, a few +2s and a very rare +3. 3E came along and decided that +4 and +5 weapons should be a major part of the game system and even +6 weapons showed up in some later splat books (or possibly the Epic Level Handbook) as artifact level.
4E went straight to +6.
The same mostly applies to other items. The powerful 1E and 2E Staffs of Power and such got weaker, the magic armor and weapons got stronger (in the straight up sense, not for other effects of the items) and were expected to be handed out.
So, what if we limit magic items to +3? PCs in a normal magic campaign are expected to get a +1 weapon, armor, and (if they still exist) neck item eventually per tier (if tiers still exist).
This limits the "Christmas tree effect" somewhat because a lot fewer (of what players consider necessary) items will be handed out.
To offset this effectiveness increase on the side of the PCs, monsters have special abilities that are used or not used dependent on how many magical items the DM hands out.
For example:
A Paragon level Elite monster has his normal stat block. In addition, the monster has a section in the stat block if the DM is following the normal magic distribution rules:
Aura: When allies of the monster are within 5 squares of him, they gain +2 to their defenses (the aura does not have to be buffs or debuffs, it could be anything beneficial to the NPCs or harmful to the PCs).
If the DM is not using those distribution rules, then he ignores this Aura. The monster could even have an aura regardless, but with slightly different power levels:
Aura:
Low magic: xxxx
Medium magic: xxxx
High magic: xxxx
The DM decides the power level of this ability.
Instead of an Aura, the monster could have an additional encounter power, or one of his Encounter powers could become At Will (which makes the monster quite a bit tougher). There are a lot of optional abilities that the game system could give to the monsters to make them weaker or tougher.
The stat block could be color coded to quickly show a DM which options are which.
And, this works great for the DM. He doesn't have to use these optional abilities, just to offset magic items. He could use them if he wants to give a given set of monsters a bit more umph, or to make a given set of monsters a bit weaker.
DM: "I want to use a Mountain Troll, but it is just too tough for my players."
Problem solved. Use the weakest version of the Mountain Troll, ignore it's optional abilities, and the players are taking on a Mountain Troll.