I don't understand this aspect of the network. Why do miners want smaller blocks from other miners? Do blocks take a long time to propagate? Are you saying that newly solved blocks are sent around on the same peer connections used to transmit messages, and that while a connection is being used to send a block (which can be large relative to the size of a transaction) it holds up the queue for individual tx?
If this is the case, perhaps an easier way to deal with the propagation of blocks is to have two overlays, one for tx and the other for blocks.
Yes there is a propagation delay for larger blocks when two blocks are produced by different miners at roughly the same time larger blocks are more likely to be orphaned. The subsidy distorts the market effect. Say you know that by making the block 4x as large you can gain 20% more fees. If this increases the risk of an oprhan by 20% then the larger block is break even. However the subsidy distorts the revenue to size ratio. 20% more fees may only mean 0.4% more total revenue if fees make up only 2% of revenue (i.e. 25 BTC subsidy + 0.5 BTC fees). As a result a 20% increase in oprhan rates isn't worth a 0.4% increase in total revenue.
As the subsidy become a smaller % of miner total compensation the effect of the distortion will be less. There has been some some brainstorming on methods to remove the "large block penalty". It likely would require a separate mining overlay.