The Treasury claimed that it would find it almost impossible to recover money from overseas students when they completed the courses in Britain.

University leaders said the system was supposed to "discriminate against British graduates" who would be charged thousands of pounds over their working lives to cover the cost of higher education. The cautions came after the Coalition refused to rule out introducing a new graduate tax system in this country.

David Willetts, the Universities Minister said that an independent review of student finance was being encouraged to investigate different ways of raising university funds and the government favored a scheme in which well-off graduates made a higher contribution to the benefits of the university education they have received.

It was seen as a support of previous plans laid by the Business Secretary, Vince Cable for student fees to be replaced with a levy based on earnings when graduates start working. But university leaders warned that the system could have serious consequences for British higher education including a loss of funds from foreign students and a reduction in competition between universities.

Under the system, all former students would be hit by a levy when they reach certain earnings threshold. Those earning the most would pay more, irrespective of their course or university. But the Russell Group, which represents 20 leading universities, said it would be impossible to police as foreign students had no tax liability in the UK.

Wendy Piatt, the group's director general said that it would be difficult to levy and collect a tax from graduates living and working overseas. A graduate tax would introduce perverse incentives for our best graduates, both home and EU, to move abroad and deprive the UK of vital skills and knowledge."

Nicholas Barr, professor of public economics at the London School of Economics, said that with graduate tax, finance remains closed-ended and the Treasury continues to control the funds

Dr Piatt said that graduate tax would provide little incentive or adequate resource for universities to drive up quality.