Keep the pension salary-sacrifice cap within National Insurance

changelog.d/2454.fixed.md

@@ -0,0 +1 @@
+- Kept the pension salary-sacrifice cap in National Insurance earnings without inflating ordinary pay or member pension contributions, retained actual supplied ordinary returns in the annual-allowance calculations, and preserved the childcare income tests in #2173.

docs/engineering/pension-annual-allowance.md

@@ -27,9 +27,11 @@ is deducted separately through `allowances`. Employee contributions represent
 net pay and personal contributions represent gross relief at source (RAS).
 Both annual-allowance income tests use
 [`annual_allowance_net_income`](../../policyengine_uk/utils/pensions.py).
-This shared helper reconstructs the model's net-income convention from actual
-income, before separately modeled pension relief, excluding the NICs-only
-salary-sacrifice return. Accordingly:
+This shared helper retains the model's net-income convention before separately
+modeled pension relief and applies net-pay/trading-loss ordering to actual
+income and member payments. The NICs-only excess never enters these amounts;
+a positive supplied legacy ordinary return is actual pay/member payment.
+Accordingly:
 
 - `pension_annual_allowance_adjusted_income` adds the total pension input
   amount to that reconstructed income, then subtracts the individual's actual
@@ -69,20 +71,19 @@ prevents Step 2 relief from exceeding the remaining income. This limit
 applies in every model year, including before the NICs cap begins in 2029.
 It can therefore change pre-2029 allowances for people whose trading-loss
 relief is limited by income and who make relievable net-pay contributions.
-Removing synthetic pay after deducting the
-original relief would retain relief calculated on income the person did not
-receive. Threshold income also recomputes [FA 2004 ss. 188–191 pension
+The helper replaces the original loss with the loss allowed after relievable
+net pay. Threshold income deducts [FA 2004 ss. 188–191 pension
 relief](https://www.legislation.gov.uk/ukpga/2004/12/section/188) on actual
 earnings and contributions.
 
 An explicitly supplied `adjusted_net_income` is authoritative. For this input
 path, the helper restores gross Gift Aid and pension relief recomputed on
-actual contributions and earnings. It does not remove returned pay or
-reconstruct trading-loss relief: the supplied ANI contains neither synthetic
-pay nor relief recalculated by the NICs reclassification. The annual-allowance
-base is therefore independent of the NICs cap on this path too.
+actual contributions and earnings. It does not remove an actual supplied
+ordinary return or reconstruct trading-loss relief: the supplied ANI already
+determines the income after those losses. The annual-allowance base is
+independent of the NICs cap on this path too.
 
-Other modeled deductions do not depend on the returned pay: brought-forward
+Other modeled deductions retain their existing treatment: brought-forward
 trade losses, capital allowances and the trading allowance depend on trading
 profits. Property finance-cost relief is a downstream tax reducer. Gift Aid's
 adjusted-net-income deduction and rate-limit extension do not reduce either
@@ -124,24 +125,23 @@ this correction does not reconstruct DB rights, overseas adjustments, unused
 allowance histories or anti-avoidance arrangements under s. 228ZB.
 
 [The NICs Act 2026](https://www.legislation.gov.uk/ukpga/2026/15/enacted)
-changes NICs treatment without changing s. 228ZA. From 2029, the model moves
-sacrifice above the NICs exemption cap into
-employee contributions and employment income. The AA calculations remove
-that synthetic return from both pay and member contributions and recompute
-income-dependent relief as described above. Pension relief preserves the
+changes NICs treatment without changing s. 228ZA. From 2029, the model includes
+sacrifice above the NICs exemption cap only in Class 1 earnings through
+`salary_sacrifice_pension_ni_excess`. It does not create ordinary pay or member
+contributions. The legacy `salary_sacrifice_returned_to_income` defaults to
+zero; a positive explicit input represents actual ordinary pay/member payment
+and is retained in the AA calculations. Pension relief preserves the
 basic RAS amount even when cash earnings are below £3,600 and gives no member
 relief from age 75. The DC input keeps the full employer sacrifice at every
 age. The threshold-income add-back uses the full
-sacrifice before this reclassification. The separate employer-cost wage
+sacrifice before the NICs cap. The separate employer-cost wage
 response can still change income; it is held fixed when testing the cap's
 statutory effect.
 
-Cap invariance covers the two taper incomes, pension input and allowance.
-Charge comparisons additionally hold ordinary income-tax inputs fixed: the
-separate ANI and personal-allowance interaction can change the marginal tax
-charged on the same excess. Ordinary income tax retains its existing
-reclassification behavior; [#2454](https://github.com/PolicyEngine/policyengine-uk/issues/2454)
-tracks that separate defect.
+With the separate wage response held fixed, the cap does not change ordinary
+pay, member payments, ANI or the personal allowance. Cap-invariance checks
+cover those paths alongside the two taper incomes, pension input, allowance
+and charge. Actual NI liability changes through the existing Class 1 curves.
 
 The taxable death-benefit and grandfathered-sacrifice inputs default to zero.
 Pension relief retains the model's aggregate earnings cap and allocation

docs/engineering/salary-sacrifice-nics.md

@@ -0,0 +1,31 @@
+# Salary sacrifice and the NICs cap
+
+`employment_income` supplies cash pay after contractual salary sacrifice, and
+`pension_contributions_via_salary_sacrifice` supplies the employer contribution
+separately. UKSimulation preserves this existing input convention; the model
+does not deduct that sacrifice a second time from cash pay.
+
+The cap limits NIC exemption, rather than returning ordinary pay or creating a
+member pension payment. `salary_sacrifice_pension_ni_excess` adds the excess once
+to `ni_class_1_income`. Full actual sacrifice still counts once in the current
+DC pension-input proxy. The capped `..._adjusted` measure is the NIC-exempt
+amount. The two NI reporting measures remain approximations; actual liability
+uses the Class 1 curves and age flags.
+
+The legacy `salary_sacrifice_returned_to_income` defaults to zero. Explicit
+ordinary-return inputs retain their previous pay/member-payment semantics.
+Actual reported member payments and the separate broad-base haircut assumption
+are unchanged. The merged #2441 age-75 member accounting and annual-allowance
+taper rules are retained: member payments before age 75, employer payments and
+full sacrifice enter the default DC input, while member payments from age 75
+are excluded. A positive supplied ordinary return is actual pay and a member
+payment in these readers too; it is not removed as an unreceived NICs return.
+The AA helper still applies the net-pay/trading-loss ordering, RAS earnings and
+age limits, supplied-ANI restoration and statutory pension-input overrides.
+
+The [NICs Act 2026](https://www.legislation.gov.uk/ukpga/2026/15/enacted)
+provides the contributions-law machinery for 2029–30 onwards. The existing
+2029-04-06 parameter and annual sampling are retained. This is not a complete
+implementation of future payroll-interval regulations. Employer contributions
+remain subject to [ITEPA 2003 s308](https://www.legislation.gov.uk/ukpga/2003/1/section/308);
+member relief separately follows [FA 2004 ss188–191](https://www.legislation.gov.uk/ukpga/2004/12/section/188).

policyengine_uk/data/fiscal_partition.yaml

@@ -481,7 +481,7 @@ exclusions:
   - {variable: ni_class_3, kind: component, head: nics_individual}
   - {variable: ni_class_4, kind: component, head: nics_individual}
   - {variable: ni_class_1_employer, kind: component, head: nics_employer}
-  - {variable: salary_sacrifice_pension_ni_employee, kind: measure_within, head: nics_individual, note: "The excess sacrifice is added back to employment_income, so Class 1 already charges it."}
+  - {variable: salary_sacrifice_pension_ni_employee, kind: measure_within, head: nics_individual, note: "The excess sacrifice is added back to ni_class_1_income, so Class 1 already charges it."}
   - {variable: salary_sacrifice_pension_ni_employer, kind: measure_within, head: nics_employer, note: "As above, for employer Class 1."}
   - {variable: tax, kind: composite, spans: [income_tax, nics_individual]}
   - {variable: benunit_tax, kind: composite, spans: [income_tax, nics_individual]}

policyengine_uk/tests/microsimulation/test_salary_sacrifice_cap_reform.py

@@ -4,11 +4,11 @@
 This tests the £2,000 salary sacrifice cap policy announced in Autumn Budget 2025,
 which takes effect from April 2029.
 
-Methodology (matching blog at https://policyengine.org/uk/research/uk-salary-sacrifice-cap):
-- Employees redirect excess above £2,000 to regular pension contributions
-- Regular pension contributions get income tax relief but NOT NI relief
+Current NI-only model routing (historical population benchmarks below):
+- Excess above £2,000 is NIC-only earnings; pension contributions stay employer payments
+- Ordinary income-tax treatment is unchanged; only NIC exemption is capped
 - Broad-base haircut: employers spread NI costs across ALL workers (~0.16% of employment income)
-- Revenue comes from NI on the redirected excess
+- Revenue comes from NI on the excess included in NI earnings
 
 Expected revenue: ~£3.3 billion in 2029-30
 
@@ -60,10 +60,10 @@ def test_salary_sacrifice_cap_revenue_impact(baseline_simulation, reform_simulat
     """
     Test that the £2,000 salary sacrifice cap raises ~£3.3 billion.
 
-    This matches the PolicyEngine blog methodology:
-    - Employees redirect excess to regular pension contributions
-    - Full excess subject to NI (broad-base haircut reduces all workers' income)
-    - Income tax relief preserved via regular pension contributions
+    The current NI-only model routing is:
+    - Excess is included only in NI earnings
+    - Broad-base haircut reduces all workers' income as a separate assumption
+    - Employer pension contributions retain their income-tax treatment
     """
     baseline_gov_balance = baseline_simulation.calculate(
         "gov_balance", POLICY_YEAR
@@ -95,7 +95,7 @@ def test_ni_increases_with_reform(baseline_simulation, reform_simulation):
     """
     Test that total NI increases when the cap is applied.
 
-    The reform adds excess salary sacrifice back to employment income,
+    The reform adds excess salary sacrifice only to NIC earnings,
     which is then subject to NI through the normal Class 1 calculation.
     """
     baseline_ni = baseline_simulation.calculate(
@@ -127,9 +127,8 @@ def test_income_tax_impact(baseline_simulation, reform_simulation):
     """
     Test the income tax impact of the reform.
 
-    The excess is added to employment income and to employee pension
-    contributions for relief. Due to pension relief caps, some people
-    don't get full relief, resulting in a small positive income tax impact.
+    The excess is NIC-only and creates no member payment or ordinary tax.
+    The separate broad-base haircut can still affect ordinary tax.
     """
     baseline_tax = baseline_simulation.calculate("income_tax", POLICY_YEAR).sum()
     reform_tax = reform_simulation.calculate("income_tax", POLICY_YEAR).sum()
@@ -141,25 +140,22 @@ def test_income_tax_impact(baseline_simulation, reform_simulation):
     print(f"Income tax change: £{tax_change / 1e9:.3f}bn")
 
     # Income tax change should be small and approximately neutral.
-    # The reform redirects excess salary sacrifice to employee pension
-    # contributions (which get income tax relief), while the total pension
-    # input for Annual Allowance purposes stays the same (no AA charge
-    # difference). Net effect is a small income tax decrease.
+    # NIC reclassification preserves actual pension input and ordinary pay.
+    # The unchanged broad-base haircut remains a separate economic effect.
     assert abs(tax_change) < 1e9, (
         f"Income tax change should be small (<£1bn), got £{tax_change / 1e9:.3f}bn"
     )
 
 
 @pytest.mark.microsimulation
-def test_excess_redirected_to_pension(reform_simulation):
+def test_excess_included_in_ni_earnings(reform_simulation):
     """
-    Test that full excess is redirected to employee pension contributions.
+    Test that full excess is included in NIC earnings.
 
-    The blog assumes employees maintain their total pension contributions
-    by redirecting the full excess to regular pension contributions.
+    Physical sacrifice remains an employer pension contribution.
     """
     redirected = reform_simulation.calculate(
-        "salary_sacrifice_returned_to_income", POLICY_YEAR
+        "salary_sacrifice_pension_ni_excess", POLICY_YEAR
     ).sum()
 
     # Should be significant (blog says £13.8bn excess - updated to current model)
@@ -215,12 +211,11 @@ def test_affected_population(reform_simulation):
 
 
 @pytest.mark.microsimulation
-def test_full_excess_redirected(reform_simulation):
+def test_full_excess_included_in_ni_earnings(reform_simulation):
     """
-    Test that the full excess is redirected (no targeted haircut).
+    Test that the full excess is included in NIC earnings (no targeted haircut).
 
-    The broad-base haircut reduces ALL workers' employment income,
-    but the full excess above cap is redirected to regular pension contributions.
+    The separate broad-base haircut still reduces ALL workers' employment income.
     """
     # Get weighted totals using map_to for proper aggregation. Only people
     # with pay have a salary sacrifice, so the excess is measured on that.
@@ -231,7 +226,7 @@ def test_full_excess_redirected(reform_simulation):
     )
     weights = reform_simulation.calculate("person_weight", POLICY_YEAR)
     redirected = reform_simulation.calculate(
-        "salary_sacrifice_returned_to_income", POLICY_YEAR, map_to="person"
+        "salary_sacrifice_pension_ni_excess", POLICY_YEAR, map_to="person"
     )
 
     cap = 2000

policyengine_uk/tests/policy/baseline/gov/hmrc/national_insurance/salary_sacrifice_pension_ni_employee.yaml

@@ -91,7 +91,7 @@
     # £100 excess * 8% = £8
     salary_sacrifice_pension_ni_employee: 100 * 0.08
 
-- name: Employee NI on full redirected excess
+- name: Employee NI on full NIC-only excess
   period: 2025
   absolute_error_margin: 0.01
   input:
@@ -103,8 +103,9 @@
   output:
     # £1,000 excess * 8% = £80
     salary_sacrifice_pension_ni_employee: (3_000 - 2_000) * 0.08
-    # Full excess is redirected (no targeted haircut)
-    salary_sacrifice_returned_to_income: 1_000
+    # Full excess enters NIC earnings (no targeted haircut)
+    salary_sacrifice_pension_ni_excess: 1_000
+    salary_sacrifice_returned_to_income: 0
 
 - name: Broad-base haircut reduces all workers employment income
   period: 2025

policyengine_uk/tests/policy/baseline/gov/hmrc/national_insurance/salary_sacrifice_pension_ni_employer.yaml

@@ -91,7 +91,7 @@
     # £3,000 excess * 15% = £450
     salary_sacrifice_pension_ni_employer: (5_000 - 2_000) * 0.15
 
-- name: Employer NI on full redirected excess
+- name: Employer NI on full NIC-only excess
   period: 2025
   absolute_error_margin: 0.01
   input:
@@ -103,5 +103,6 @@
   output:
     # £1,000 excess * 15% = £150
     salary_sacrifice_pension_ni_employer: (3_000 - 2_000) * 0.15
-    # Full excess is redirected (no targeted haircut)
-    salary_sacrifice_returned_to_income: 1_000
+    # Full excess enters NIC earnings (no targeted haircut)
+    salary_sacrifice_pension_ni_excess: 1_000
+    salary_sacrifice_returned_to_income: 0

policyengine_uk/tests/policy/baseline/gov/hmrc/pensions/pension_annual_allowance.yaml

@@ -241,11 +241,11 @@
     pension_annual_allowance_threshold_income: 220_000
     pension_annual_allowance: 40_000
 
-# The NICs cap redirects 28,000 to employee contributions and the broad-base
-# haircut reduces pay by 280. Threshold income still adds back all 30,000:
-# 202,720 - 28,000 + 30,000 = 204,720. Pension input remains 130,000,
-# adjusted income is 202,720 + 130,000 - 28,000 = 304,720, and the charge
-# is (130,000 - 37,640) * 45% = 41,562.
+# The unchanged broad-base haircut reduces actual pay by 280. The 28,000
+# NICs excess creates neither ordinary pay nor a member payment. Threshold
+# income still adds back all 30,000: 174,720 + 30,000 = 204,720. Pension
+# input remains 130,000, adjusted income is 174,720 + 130,000 = 304,720,
+# and the charge is (130,000 - 37,640) * 45% = 41,562.
 - name: The 2029 NICs cap does not limit the salary sacrifice threshold income addback
   period: 2029
   input:
@@ -254,8 +254,10 @@
     pension_contributions_via_salary_sacrifice: 30_000
     employer_pension_contributions: 100_000
   output:
-    employment_income: 202_720
-    pension_contributions_relief: 28_000
+    employment_income: 174_720
+    pension_contributions_relief: 0
+    salary_sacrifice_pension_ni_excess: 28_000
+    ni_class_1_income: 202_720
     pension_contributions_for_annual_allowance: 130_000
     pension_annual_allowance_threshold_income: 204_720
     pension_annual_allowance_adjusted_income: 304_720