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Andrew Coleman looks at the options facing the Government for funding the Covid-related public debt

Andrew Coleman looks at the options facing the Government for funding the Covid-related public debt
Where our debt and tax decisions are made ...
Image sourced from

By Andrew Coleman*

James Buchanan, the economist who was awarded the Nobel prize for his work analysing the way politicians make economic policy decisions, attributed much of his insight to a year spent living in Italy in the late 1940s.

One of the things he discovered was that most Italians did not think that politicians had the interests of the people at the forefront of their minds; rather politicians were believed to pursue their own interests, and if these coincided with the interests of the people then the people were fortunate.

For Buchanan, this was the seed of Public Choice theory. Another thing he discovered was the work of an otherwise obscure Italian public finance economist, Antonio de Viti de Marco. de Viti de Marco had a great deal of influence on his thinking.

Unfortunately, I have not read de Viti de Marco’s book, first published in 1888, so what follows is second hand, based on some of Buchanan’s work and also the excellent book by Richard Salsman “The political economy of public debt.”

De Viti de Marco was interested in the circumstances in which large public deficits could be justified. He argued that deficits were occasionally appropriate when the government faced some sort of emergency and needed to raise a lot of funds to deal with the emergency. The most obvious example is a war: it requires the purchase of a large amount of military (and medical) equipment, as well as the recruitment of a large number of military and medical personnel.

He suggested that there were two basic ways a government could raise the funds. The first was to raise taxes by the full amount immediately. People would find the money by cutting back on expenditure, or by borrowing if cutting back on expenditure were too onerous and they had the ability to raise a loan.

The second was for the Government to borrow – essentially to borrow on behalf of the people, and thus reduce their need to cut expenses or borrow to pay the taxes. People who found it easiest to save would buy the government bonds, and provide a real service to those people who were less able to immediately increase their savings, or those who could only borrow at high interest rates. They would be repaid in due course for the service they provided to everyone else. Instead of a large immediate increase in taxes, taxes would increase by a smaller amount for a longer period in subsequent years.

The situation facing New Zealand at the moment seems similar, although there are two additional options.

In response to the Covid-19 virus and the restrictions imposed on society in response to it, the government could:

(i) tell people who lost their jobs that it was their bad luck to be working in the wrong sectors, and that they should borrow to get through the emergency until they could find employment in some other sector, or with their original employers if the jobs were still there when the emergency passed.

(ii) increase taxes by large amounts immediately on those who remain in employment (and those in receipt of capital income) in order to provide transfer payments to those unemployed or those whose businesses had suffered;

(iii) borrow from those most able to lend, to reduce the costs of option (ii), to be repaid by future taxes;

(iv) create money to provide the transfers.

Option (iii) is the option that seems likely de Viti de Marco would favour, were he 162 and still kicking around. But to some extent the first three options all involve borrowing and consumption cuts.

While the first option seems unpalatable at first sight, unless the size of the transfer payments is extremely generous, people who are unemployed (or who have much reduced business income) are likely to be forced to borrow on their own behalf to maintain consumption levels.

Indeed, the extent that option (i) is part of the solution depends on the size of the transfers.

In principle, people who lose their jobs/businesses as a result of the Corona crisis can issue an IOU to the bank in exchange for cash, to be paid from future income or asset sales. If they do, savers will emerge to hold the deposits associated with these IOUs.  

In the second option, the costs to the unemployed are distributed over the wider community through steep increases in taxes. To the extent that the steep increase in taxes cause hardship on individual taxpayers, taxpayers can issue IOUs to the bank to raise cash to pay taxes. Once again, savers will emerge to hold the deposits associated with these IOUs.

In the third option, transfers are made to unemployed people, but this time they are financed by government issued IOUs. Once again, savers emerge to hold the deposits associated with these IOUs, but in this case the interest rates are likely to be lower as the Government is a less risky borrower. (Thank you, Mr and Mrs Saver, wherever you are, for reducing the cost to the community of dealing with the disaster.)

Note, however, that in the third option, the people who have to repay the loan are not identified unless the government provides specific details about the taxes that will be imposed in the future to repay the loans. Thus, the third option differs from the second option not only because it is more efficient, raising funds from those most able and willing to pay, but because it is silent about who ultimately pays for the transfers.

This article is not the place to talk about the costs of the fourth option.

There is a long tradition of governments printing money to finance expenditure, some of which has been popularised in a new version of economic theory called “Modern Monetary Theory”.

Not many economists believe that monetarising debt is costless; rather it typically redistributes the costs in ways that are not well understood.

Historically the excessive issue of money rather than debt to finance government expenditure has been associated with inflation, which shifts the cost to those people who had lent money to other parties. MMT theorists would do the world a service if they provided formal analysis of the distributional consequences of governments issuing money rather than debt to fund emergency expenditures, but this has not yet been forthcoming in a manner that most economists find compelling.

The New Zealand Government seems to be opting for options (i) and (iii), although it is muddying the waters a bit by having the Reserve Bank purchase government debt.

There seems little doubt that the Government deficit is increasing, and debt is forecast to increase by a large amount over the next few years, perhaps by $60 billion. Once again we should be grateful to the savers, for by providing money at low interest rates they are preventing worse outcomes.

Niggling worries

There are two niggling worries.

The first, if you are a lender, is that the government may not pay you back in real terms what you think you will be getting.

Unfortunately, the post 1950 historical experience is that governments find ways to cheat their creditors, normally by inflation.

Will this happen again? Who knows? But the New Zealand Government has a long and inglorious history of short-changing lenders (savers). For example, it is one of the few countries that taxes the inflation component of interest income earned by people who are saving for retirement, a practice that most economists and most OECD countries find unconscionable.

Why the New Zealand government believes lenders deserve to pay the highest taxes on real income in the country is a mystery, although it could be because it believes that people who lend are either particularly undeserving or particularly unsophisticated so that it is either equitable or efficient to impose on them very high effective tax rates while subsidising people who borrow to invest.

This position was supported by the Tax Working Group last year, consistent with IRD and Treasury advice over a three-decade period, and seems unlikely to change. In addition, recent changes to the Reserve Bank policy targets agreement will make it easier to justify future inflation.

Is it really credible to believe that the next Central Bank governor, who ever she or he is, will be prepared to raise interest rates to control inflation if unemployment is persistently high?

The second issue is somewhat more straightforward. The Government has made no announcements of the types of taxes that are likely to be raised to repay the debt, and thus has made no attempt to identify the likely taxpayers of the future.

New Zealand governments have traditionally been willing to impose some of the highest taxes on capital income (particularly interest income) in the OECD, proving that governments have no fear of the possible distortionary consequences of capital income taxes.

Successive governments have also demonstrated a willingness to impose high taxes on young and future generations, by adopting unfunded pay-as-you-go retirement income policies.

In contrast, for three decades New Zealand governments have imposed some of the lowest taxes on labour income in the OECD, particularly on people with very high labour incomes.

I am completely out of the political loop, and have no knowledge whether current politicians think they should accentuate these positions, or reverse them. All I know, following the insights of James Buchanan, is that it is unrealistic to expect a government to announce plans to raise future taxes before an election, no matter how much it would be in the public interest to do so.

*Andrew Coleman teaches public finance at the University of Otago.

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Simple! Tax the ultra-rich more, as recommended by Stephen Tindall. There is even a movement in the United States by multi-millionaires and billionaires themselves to do this.

I would like a society like the following: (It's a bit slow to get going but persevere; this will solve everything to do with taxation and land.)

Might be time to sacrifice OVER LEVERAGED Boomers on the alter of house-price-declines.

Obviously not just the Boomers.

There seems little doubt that the Government deficit is increasing, and debt is forecast to increase by a large amount over the next few years, perhaps by $60 billion. Once again we should be grateful to the savers, for by providing money at low interest rates they are preventing worse outcomes.

Are banks not underwriting government debt issuance by writing up both sides of their balance sheets - ie banks purchase government's IOUs (bank asset) with their own IOUs (government deposit)? Government spends the deposit into the economy via transfer payments, banks swap fixed interest rate government bonds, via RBNZ QE, for floating rate government debt. Thereafter, banks elect to receive fixed in the IR swap market hoping RBNZ government bond purchases spur lower term government bond yields and increasingly negative IR swap yields. Or a deflationary economic outlook may do the job for both the RBNZ and banks and they just follow market interest rates down.

Very good points about how NZ has comparatively high taxes on capital and low taxes on Labour. I know you've explained this to the leader of TOP, who until very recently wanted to tax all major assets annually. Deaf ears. This would obviously destroy our productivity. But they are Olympians at mental gymnastics, so convinced themselves that taxing an asset incentives it to be used more efficiently. They have now dropped most of this insane policy even though they really want to do it - the only insane part remaining is their land tax.

Interesting that you think all capital incomes are heavily taxed.
That is NOT Coleman's position at all. He is instead incredibly staunch on the fact that we under-tax incomes from capital assets such as housing. He has argued many times that a solution to this is a tax on imputed rent.


Andrew Coleman - “I'm not a huge supporter of taxing imaginary income” “Personally, I prefer a system of progressive consumption taxes”

Imputed = Imaginary. I disagree with him on land tax, but not on taxation of capital based on imaginary income like TOP wanted to. Assume he supports CGT, which I have no objection to in principle.

Coleman said capital is taxed at a comparatively high rate. I simply agree. Don’t try put words in my mouth.

“The basic reason why New Zealand has relatively high taxes on capital incomes and relatively low taxes on labour incomes is that New Zealand has much smaller social security taxes than almost all other OECD countries, and does not have a compulsory contributory superannuation system.”

And I never said he personally advocated the tax. I said he has highlighted that it is a solution to the fact that we under tax capital income from housing relative to other incomes.
That is what is killing our productivity.

capital income from housing

Owner occupied housing earns no income until it is sold. If it is sold at a profit, a reasonable case can be made for CGT to be paid at that point. For rental properties, the rental income should of course be taxed, as should any capital gain when the property is sold.

But to say that land or any other asset should be taxed ever year based on imaginary income is absurd. It is just as illogical to say that the imaginary income from my house/land should be taxed as it is to say that the imaginary income from my bicycle should be taxed annually.

So your argument is "It is wrong because I think it is."
"I prefer a tax that fails to address any of the issues we are attempting to solve."

No, I think it is wrong for many reasons. Reason 1 of 1000: taxing imaginary income creates a fundamental disconnect between requirement to pay and ability to pay. E.g. farmers having to pay tax on their land even in years they earn no income due to drought. Retirees being unable to pay the tax bill associated with the non-existent income they are earning from their home.

asset taxes are not income taxes.

They are “imputed income” taxes. I.e. “imaginary income” taxes.

See RFRM tax.

Oh. That old stickler.
Tell us #2 of 1000

Reason 2 of 1000. The benefit/utility I get from house/property stays constant from the day I purchase it, yet I would be required to pay more tax as it increases in value. Illogical.

You mean it increases like rent seems to regardless of an increase in utility for the renter?

I am sure your radiant good looks have utility for you ( and a sizable earning potential , realized or not ) ; would it not be logical to tax you on that ?

But I didnt pay for them..

. . but according to you the amount of tax I should be paying on my house should not depend on how much I paid for it ?

That's not at all what underpins a tax on imputed income.
The tax is on the imputed return from the equity stake in the asset. i.e. choosing to buy a house is an investment in one class over another yet it is taxed differently.
I dunno how this translates to a natural endowment of good looks.

ok , so if it is a "natural" endowment it does not count somehow . What if you enhanced your health ( or your looks , or your gender ) through expensive surgery ? You could have bought some shares instead ...

So your question is whether we should tax people on their decision to undertake elective surgery to increase their income...which is taxed...
Wanna rethink?

Hm .. it is you who needs to rethink .. in my example they did not increase their income - but they could have if they chose to ; it is that imaginary ( not real / realized ) income again .
The point of the example is that once you start "imagining" income in order to tax it you will inevitably/logically see it everywhere . Your distinction between "natural" endowment and the rest simply does not hold water , especially given that you propose to tax on the "present" value , not the value at the time of purchase.

Well of course it does. If you are naturally endowed, you do not allocate any capital to it so there is no basis to tax it in this context.
The argument here is that people allocate capital to avenues where it is taxed the least and this should be eliminated in order to mitigate the perverse incentives this creates. One way is a tax on imputed returns.

Surgery is consumed. It's not an asset. You cannot resell it.

Tbh I'm too old to keep going round and round in circles with what-ifs.

No, not the decision to undergo surgery. The utility you get from the enhanced looks that you paid for. The idea is exactly as vacuous as your imputed rent.

Whether you paid for the surgery is actually irrelevant. Just as whether the owner paid for the house is irrelevant (e.g if they were gifted it).

A walk on the beach provides utility/enjoyment, should I be charged imputed rent for that?

*Puts on TOP rosette* Well, beachside property is extremely expensive, and if we take the surrounding beachfront property values as an indicator, and then took the area you occupy when you walk along the beach at any given time and approximate the area of the corridor you walked along the beach, then we can derive a use value for how much space your walk took up and how much utility you benefited from.

Wait, did you take your dog? You derive joy from your dog right? Well, what if you ate your dog? There'd be sustenance value in that too. So that's fair game.


Simply factors of rental supply and demand affecting rental price. Like when the property owner purchased their house for hundreds of thousands of dollars, that price was affected by house supply and demand. You incur the expense of buying an asset so that you don’t have to pay ever increasing rent for said asset. That is how property ownership works, unless you live in a communist state where the government owns everything. Paying to procure an asset only to pay rent for it thereafter doesn’t make much sense.

Do you think everyone with a bicycle should be charged a bicycle tax because some people rent their bicycles and it just isn’t fair that bicycle owners aren’t incurring this ongoing cost? Bicycle owners enjoying the utility of the asset they paid for without paying tax on that utility/imputed “income”.

But housing is a function of current and future accommodation costs. It's not a hedge against future housing costs as you imply.
So, when you purchase that property, you do so in the expectation that the marginal willingness to pay for the amenity value is increasing over time (a la rents). So, effectively you are paying for future rent increases.

I'm not for or against a tax on imputed rents. In theory it is smart, in practice it is difficult now with the state it we are in. I just find it funny that you have such a hatred for it, based on some warped understanding of the motivation.

It's not a hedge against future housing costs as you imply.

Baseless assertion informed by what? Your opinion? People buy houses for a multitude of reasons. A hedge against future housing costs happens to be one of them. Certainly one of the reasons I purchased mine.

Again, purchasing an asset means you don’t pay rent for it. That is what ownership is. You’re fixated on the idea that rent is owed by the asset’s owner. This is not how the free market works. Asset owners don’t pay rent to the community in a free market system of property ownership. You have a fundamental problem with the free market and what it means to own an asset.

Please answer my bicycle question.

The arbitrary bicycle analogy?
It is a strawman argument. But hey if that is how you wanna justify your position, go ahead.

I'm not at all fixated that rent is owed by the owner, at all. This is you, again, confusing the argument. The 'rent' is the return on the investment in the asset. This is not taxed commensurately with returns on other capital investments. This is the argument.

Yes, the bicycle analogy. What is the difference in principle between taxing the imputed rent on an owner-occupied house, and taxing the imputed rent from all other assets an individual owns, like a bicycle? If it is fair and reasonable for the former, it surely is fair and reasonable for the latter...

There is the example of bonds bought at discount to par accruing capital annually on a pro rata basis until par redemption being liable for income tax annually at one's top marginal tax rate.

Could the avoidance of owner's equivalent rent be taxed on the same basis?

There was a scheme advocated about 18 months ago that freehold owner occupiers should be taxed on the unrealised outgoings a freehold home provides.. i.e. you would be taxed on the amount of outgoings (rent) you aren't actually paying due to you owning your own home. This is the sort of absolute disconnect that some of our "elected" (list) MPs are purveying on NZ.

They have a tenuous grasp on reality if they think New Zealanders would ever accept this. This policy would just create a nation of renters, serfs to the landlord government.

So after incentivising all money into centrally-supported land speculation, the answer to NZ's problems is to tax the young, working and unlanded folk harder.

The beatings will continue until morale improves.

"In contrast, for three decades New Zealand governments have imposed some of the lowest taxes on labour income in the OECD, particularly on people with very high labour incomes."

Is this in terms of purely percentage rates alone, or is this when scaled to things like how far your income goes when it comes to costs of housing, etc? Worth keeping in mind things like student loan payment obligations kick in here at half of what they do in Australia and their repayment rates scale with income, despite our lower wages and massively inflated living costs. $70k won't get you a mortgage here, but it will get you a ticket to the top tax rate for every nominal future dollar you earn. Bizarrely, you still qualify for an in-work tax credit in the event you have a child. $70K isn't even halfway down the WFFTC annual income tables.

NZ has also managed to tax inflation on earnings for many people through bracket creep. I'm unsure why this is so offensive to those with the luxury of a cash buffer, but unworthy of mention when it comes our apparently low PAYE rates.

The additional debt will never be repaid, nor does it need to be. Even worst case scenario we still have one of the better public debt to GDP ratio's. The RBNZ will finance the new debt until it is inflated away over time and the interest servicing expense will barely change due to lower rates.

The additional debt will never be repaid, nor does it need to be.

Meaning it will be rolled over at redemption? Extend and pretend?

The RBNZ will finance the new debt until it is inflated away over time and the interest servicing expense will barely change due to lower rates.

Near zero to negative interest rate policies overseen by global central banks, for more than a decade in some cases, indicate little to no inflation prospects over a chosen time horizon. Inflation is historically associated with higher interest rates.

Ok, but if there isn't inflation the QE program has been a raging success and we should just keep propping up the economy. Cut taxes, issue more bonds and he RBNZ buys them. Right up until the currency collapses and inflation goes nuts.

IMF global economic growth rates including those nations executing QE programmes are below trend GDP growth extrapolated for the two decades before GFC.

I don't buy that logic sorry, we just don't know the counter-factual. QE was implemented in response to a crisis that may have led to a depression without it.

My point is that if we don't get inflation, then QE has been costless. Why not cut taxes and pump QE up even further?

I don't buy that logic sorry, we just don't know the counter-factual.

We had QE in the G3 economies for the last decade plus some and global GDP growth was poor for all of us.

I realise that, but what would GDP have been without QE? It was introduced to counter a serious financial crisis. We need to implement QE when the economy is booming to conclude it doesn't generate inflation.

The counter factual is always without evidence. But as I noted, QE is failing to ignite historical economic growth rates and the compounding impact is enormous given citizens have such short productive employment windows.

Symmetric QE together with symmetric CPI goals.? - yeah right!!!!
Fed's Harper had this to say recently.

We’ve been saying for a long time that the 2% inflation goal is symmetric, which means we should overshoot it. We were having a difficult time doing that, like all developed economies.Link

Inflation isn't driven by too much money, it's driven by Demography.

Thanks Audaxes - the world has changed, but we have a lot of people still applying the past to the future.

And as for what GDP would be without QE? Negative since 2008.

And when would GDP have turned negative if physical depletion/degradation was fully counted? Arguably 1970.

This is wrong, future generations still have to pay by increase taxes and in fact have to pay additional taxes as they have to pay the interest payments by taxes as well as principal payments
" (iii) borrow from those most able to lend, to reduce the costs of option (ii), to be repaid by future taxes; "

It is unfortunate that Mr Coleman does not explore Option 4 more, or fully. What i read of MMT, it holds the most complete solution. But, and this is a very big but, for the promises of MMT to be realised there is great responsibility on the Government to properly and fully regulate the economy. If they were to fail in this, then potentially they could be held hostage by the big players at the expense of the ordinary people, something that is already happening to some degree.

"MMT theorists would do the world a service if they provided a formal analysis of the distributional consequences of governments issuing money "
Someone HAS to pay. Will it be you? Me? MMT doesn't tell us, but I'll guarantee you one thing, it will include you and me!

No, you are working on the old system before Bretton Woods when the Gold standard was dropped. Then the principle was that all the money had to be backed up by gold. This identified a easily defined cap on the amount of money in circulation. But that was dropped in the 70s. Since then the amount of money in circulation has not been effectively capped. Under MMT this should lead to inflation. But where Government regulation is lacking such inflation can be in just one area - try housing. Money in itself is not debt. this too is an out dated concept. Consider that someone with $1000 v some one without. Who has the debt? On what basis?

Under MMT the Government, as the sovereign owner of our fiat currency - the NZ dollar, can create as much money as it wants to fund what ever it wants. That does not create debt, but it does use that money to buy things like labour and goods, or outcomes. Taxation is used to control the amount of money in circulation and thus control inflation. So for NZ successive Governments (and RBNZ Governors) have abrogated their responsibility in controlling the amount of money in circulation, effectively handing it to the private banks, who of course took advantage by adding to it without restraint through the creation of credit to loan out to their customer base, which must be paid back with real money. The results? Easy money in property so huge bank profits, skyrocketing housing and accommodation costs and a seriously unbalanced economy. The Government's response? To take money from the real economy (the rest of it outside of housing) through taxation, and provide subsidies to landlords which has just encouraged the housing problem while limiting the amount of money in the rest of the economy driving that inflation down.

So for your quote in bold - try thinking it through without the convoluted double speak of economists and accountant too rooted in the old paradigms.

Inflation is used to control the amount of money in circulation , a typo? shouldn't it read taxation.

Oops, correct. Thank you corrected now.

Under MMT the Government, as the sovereign owner of our fiat currency - the NZ dollar, can create as much money as it wants to fund what ever it wants. That does not create debt, but it does use that money to buy things like labour and goods, or outcomes

Under current NZ law the RBNZ recognises currency in circulation as a liability. Please explain what a liability is - it is certainly not a government asset.

Yes it does, and money created by a Government is done so for a purpose. That purpose is the liability, the Government effectively enters into a commitment with it's constituents to do something. Is all the money in circulation a liability for the Government? Depends on a broader definition of what a liability is. How can it be out side of creating too much or not enough inflation? Are you conflating the definition of debt with that of liability? The liability for the RBNZ and the Government is in managing the effect of the money in circulation.

Is all the money in circulation a liability for the Government? Depends on a broader definition of what a liability is

The government specifically authorises banks to creat credit by purchasing borrower's IOUs with their IOUs (deposits) which are fungible with government currency in circulation. Both are liabilities to the respective institutions. More detail here (PDF)

Please don't obfuscate about the definition of a liability - just answer my previous question in plain language we can all understand with respect to the RBNZ's published understanding of the situation.

I own a house, no mortgage. This ownership creates liabilities for me, but not debt. How much simpler can that be? Try this -"debt is referred to as borrowed money while liability is the obligation of any kind — may it be money or service to another individual or party"

We are talking about the balance sheet of NZ's' central bank, not garden shed maintenance costs.

Yes and the question is whether money created by a Government constitutes a debt or a liability as seen through the lens of the RBNZ balance sheets. I suggest it is a liability but not necessarily a debt. The RBNZ identifies it as a liability but not a debt. To argue they are the same thing is to conflate their definition.

MMT is an accurate description of how our governments finances have worked for the last thirty five years since we went off an fixed exchange rate and floated the dollar. Only the government can create NZ dollars and they cannot legally come from anywhere else and so logically any money that it borrows it must have first created by spending it into existence. Spending comes first taxation and borrowing occur afterwards.

No it's not. the Government hasn't created funds until just recently. It has funded all of it's policies through taxation and borrowing. However the trading (private) banks have effectively created money to fund the housing ponzi, which means the Government has been negligent in it's responsibilities towards the money supply, resulting in significant inflation occurring in the housing sector, but bugger all elsewhere.

The banking system cannot operate without reserves to operate their exchange settlement accounts and only the government can create these reserves, government spending is the major source of these reserves. The government drains these reserves again through its borrowing program. Only the government can create net financial assets for the private sector to finance savings, banks cannot create net financial assets as the assets and liabilities that they create in the private sector cancel each other out. Some further explanation here.
Economist Prof Bill Mitchell explains why governments borrow on his blog here.
Part one.
Part two.

Don't disagree. It is how the current money system works, but it is NOT MMT.

That is how all of the major MMT economists describe it, economists such as Stephanie Kelton, Bill Mitchell, Randall Wray, Steven Hail and Warren Mosler, ect. Where are you getting your information from?

Stephanie Kelton states that Governments do not need to borrow to fund their spending. As sovereign owners of a fiat currency, they can simply create the money to fund their spending. They tax to control inflation and behaviour. That is the option of MMT. the fact that Governments continue to tax and borrow to fund their spending is effectively keeping one foot in the old system. They are reluctant to take back control of the amount of money in the system.

All government spending is made by issuing new currency, taxation and borrowing do not fund it. It makes no sense for the government to borrow back its own "IOUs" to re spend when it can just issue new ones. Bill Mitchell explains why they do it in the links that I gave you.

Not sure I agree with this, what is your definition of reserves? Bank ETS balances are simply what's left after the banks have settled with one another. The RBNZ manage the liquidity in the system with OMO's and buy and sell T Bills and RB Bills to balance it. The Govt doesn't create the reserves

Bill Mitchell explains here.
"Only government-non-government transactions (which in MMT are termed vertical transactions) can change the net reserve position. All transactions between non-government entities net to zero (and so cannot alter the volume of overall reserves)"
The government spends by issuing currency and crediting bank accounts, this in essence is creating reserves in the banking system.

The private banking system works off deposits from it's customer base or it goes out to borrow money from other sources. that is referred to as the capital that lies behind their lending. But the private banks by their nature should be working in a different way from the RBNZ as they have different purposes.

Not true, capital is equity and deposits etc are debt.

Check it out, a part of the capital reserves that the RBNZ requires of banks to back up their lending are depositors funds. And indeed these funds are considered legally to be owned by the banks. Depositors are just unsecured creditors.

Don't you mean shareholder's equity? -

Funding/debt/deposits are not capital, though some forms of hybrid debt are lower tier 2 capital. Capital is equity, retained earnings etc.

AA good link, you notice NZ banks own $53bn worth of bonds as HQLA for their LCR ratio's. Pre-covid there was only $60b of NZGB on issue so the banking system is financing much of NZ's debt.