A couple ideas I thought were interesting were to have a loot boost to those who don't flag (Like a 1% boost to all loot or something.). But I don't think anything that includes an OOC flag is a proper solution. There simply is no good IC way to explain the flag. Demeanor flags? Those make sense from an in character perspective. You could say that maybe those people are guarding their pockets? Well, that system is already in place - the WATCH verb (Yet another tool people have against thieves.)
Another idea is to simply implement a system that forces the thief to give the stolen items back if he gets caught. But do remember, by making things crazy harsh, it could make pickpocketing at lower levels completely unviable. Someone that isn't capped is going to get caught a lot, so they are already facing heavy consequences.
Honestly, the system is pretty robust as it is. I don't know why negatives need to be tacked on. The boosts to it with NPCs is a positive direction and I think the flag part should just be dropped. But I'm open to compromise if that is the only way to prevent the flag as is currently proposed.