IPhone – What version of iOS is the iPhone capable of running

From my experience, 3.1.3 is indeed the best version for iPhone 3G, if you don't want any new or updated app. I've installed 4.2 on an iPhone 3G and it does become slower, though not so bad. If you put side to side a 3G with iOS 3 and one with any version of iOS 4, you'll see the 3 outperforming the 4 for most tasks (other than some native multi-tasking maybe). Other than the slightly faster performance, the best iOS for any iDevice is the latest one, like wjlafrance said.

Unless it is jailbroken, I can't tell what could possibly make iOS 3 slow. On iOS 4 it is only multitasking that can harm the performance AFAIK. Same issue with jailbreaking - gets slow if you install too much stuff running on the background. And an old device will suffer aging impact only on the battery. Hopefully a fresh restore would solve the "sluggish" but I'm afraid it might not.

Anyway you can easily* downgrade without jailbreaking. On 3G, you just* need the right file, enter DFU mode and option+click on Restore from iTunes.

* It is that simple, but there is more to it and it can become complicated. If you need more details, try this guide on lifehacker or this another even more detailed one on redmondpie.

Ok, so after some quick googling and reading some Apple forums, it looks like iCloud (in iOS 5.x) isn't ready for prime time. I've done the following and now iOS 5.x seems a lot snappier.

1. Disabled iCloud everywhere (Settings -> iCloud)

   Disable all apps then Scroll down and hit "Storage and Backup" and disable iCloud backups. If you really want to go strong, just delete your iCloud account setting (on your phone, Settings -> iCloud -> scroll to bottom)

2. Disabled sending data to Apple (Settings -> General -> About -> Diagnostic & Usage -> "Don't send")

3. Minimized Location Services (Settings -> Location services)

   I kept it ON globally, but disabled it for certain Apps Most importantly, disabled it for "Diagnostic & Usage" as well as "Location based iAds" (Settings -> Location services -> Scroll to bottom -> System Services)

4. Disabled notifications for the calendar (Settings -> Notification)

   I also removed notifications for many other apps that had added themselves ... However, I suspect this is fixed in iOS 5.0.1 under their "Battery issue fixed" patch. Earlier, Calendar notifications would hang causing CPU to be stuck 100%, draining the battery and leaving little CPU for other items.

Also, there are two apps, SysStatsMon and System Status. Both are good tools to see CPU usage on your iOS device. About 5+ seconds after launching them under normal circumstances, your CPU should be in the 5-15% range.