I'm playing the freestyle (non-campaign) game. I went to war with the only other enemy I've found (after 875 turns!); a minor enemy with a single, un-improved, level 1 city. After killing him and taking his city, the city refuses to grow beyond level 1.
At one point I had 158/50 citizens, so I demolished all the housing, which dropped me down to 40/50. I figured maybe if I crossed the 50 threshhold again it'd trigger the level-up process. But it didn't. I'm currently at 58/50 and still level 1.