Yes, kids read at a lower level at school because they're not just decoding and being carried along by the excitement of the story. In reading groups they're being asked hard questions, analysing the text, remembering small details, reading between the lines, inferring things about the character's motivations, etc. You'd find that easier to do on a John Grisham book than on Chaucer because the low level book (most mass market fiction is about 6th grade level) needs no concentration to decode. Because these kids are just learning how to use their higher order thinking skills on text it helps to have a comparatively easy book to practice on.
The key word in that last sentence is "comparatively." Where this process falls down for gifted early readers is that the reading level becomes "shockingly" or "insultingly" easy given their ability levels. If the reading is far below their level, you lose their interest, and they miss out on those tiny details that they're asked to regurgitate in order to demonstrate what they term, at that level, "comprehension."
Also, the questions in early elementary are often stupid, obvious questions. For example, a sample text might read:
"The old man decided to go outside. He put on his pants. He put on his shoes. He put on his hat."
And a "comprehension question" might read: "Why did the old man put on his hat?"
The expected answer is, "because he decided to go outside." But it's a stupid question, because this is not the '40s, and people don't always wear a hat outdoors anymore. So a gifted reader naturally concludes that the text did not give a proper reason why he wore a hat, and tries to guess, based on the little context given.
Hmmm... we know he's old. "Because he's bald?"
The answer is marked wrong, and the teacher then reports the child is the one with comprehension problem, rather than the other way around.
