> They have an incentive to pad everything and to never lower costs because their budget will be lowered otherwise.

Sure, but in the absence of widespread corruption (which until now, the US has been relatively clear of) they don't just get to go home with that budget in their pocket. They're still paid on standardized pay scales. Any extra budget still gets spent on the actual org or project, with the exception of random things like travel or office supplies.

The contractor takes home every extra dollar as profit.

I don't disagree at all that neither system is perfect, of course, but just saying.