The original design is far better... but its also not so easy to produce.
Try this: A simple 4" diameter cylinder, connected to the main shaft. Maybe some toy wheel or roller, which has a perfectly centered hole already on it.
Use a laser mouse to read both X and Y values, by placing it close to the side of the cylinder (not the top or bottom) de-cased if possible. A decent one, which can read a few mm even when lifted off of a flat surface. Logitec versions can adjust DPI sensitivity pretty easily. Im pretty sure mame allows mouse input for the vertical axis on DOT.
If not, you can just use the X axis for the mouse, and add switches for the Y. However, Id recommend Leaf switches, as they can be adjusted to react far easier and quicker, are far more durable (wont wear like a plastic micro-switch actuator... and even the smaller roller switches are not that smooth, nor long lasting) ,and you do not have to overcome that click-pressure threshold before activation.
In Aiming levels, aiming should be quick and smooth/fluid. Its hard enough with the real controller, which has almost no frictional changes when pull / pushed + spinning.
The alternative, could be to use a regular spinner... but use a foot-pedal setup to control height changes.