The flag system is definitely broken, because it encourages tit for tat, agreed. (Followed.)
We simply need more quality curators with high SP who can upvote other content, to decrease payout to low quality content. The rewards pool is fixed, after all. (I'll try to get the MathOverflow community on here, if LaTeX via MathJax or KaTeX is enabled.)
That said, I have some idea why Ned and Dan implemented flagging originally; it immediately, rather than over time, decreases the rewards for poor quality content. (Like this blacklist itself! If Steem, Inc. flagged it, good. That blacklist, with Ned, Dan, Jerry, you, other well known members on it, is clearly extortion of some sort.)