Universities that enrol students in degree courses with few career prospects would be stripped of government funding under a plan proposed by Liberal Democrat David Leyonhjelm.
The senator floated the idea during negotiations with the government over its failed higher education deregulation reforms.
He says Education Minister Christopher Pyne is supportive of the proposal.
Mr Pyne wrote to Senator Leyonhjelm on Tuesday to formally propose that grant funding be linked to the number of students paying off HECS debt.
The senator says universities have created a "moral hazard" by selling courses with no career prospects to vulnerable young students.
If universities offered degrees for which HECS loans can't be repaid, they should "bear some of the consequences of that".
Senator Leyonhjelm said he knew some people with environmental studies degrees who were now struggling to find a job.
They had expected they would end up doing something positive for the environment.
"All they end up doing is waiting on tables or serving in bars," the senator told reporters in Canberra on Thursday.
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