“We are the only country in the world crazy enough to prop up our sovereign research capability with international funds. It produces huge distortions and vulnerabilities in our higher education system."
I suggest this could be addressed with an Australian Sovereign Research Wealth Fund. International student fees would be treated as a windfall, with a levy applied. The levy would go into the central research fund. This would be invested in developing the results of Australian research. The earnings from the fund would be distributed as competitive grants to universities.
The levy would be calculated at a level which would allow university to retain a proportion of the surplus from international student fees. This could be set at a 75% share for universities initially, reducing to 25% over ten years.
It might be argued that taking away most of the revenue from international students would be a disincentive for universities to have them. But a university would still be receiving a reasonable return on each student. Also it could be argued that this is the government profiting from the hard work of universities. But the money would be going back to universities in the form of research grants. Also it is not the quality of individual institutions which attracts students, as Australia as a desirable destination.