Why do consultants or contractors make more money than employees?
The benefits and taxes thing, in my opinion is the biggie.
Most people don't realize that the cost to the company for a full-time employee with benefits can be 2x or even 3x the amount they see in their paycheck. Health plans are extremely expensive. Even if you are having money taken from your check for health insurance, it is often just a fraction of the total cost, and the employer is subsidizing the rest.
More expensive benefits that contractors don't typically get are 401K matches and paid vacation days. When contractors call in sick or don't work because it is a national holiday, they don't get paid for that day.
Also, see that line on your paycheck deducting for Social security and Medicare? That is only half of the tax. The employer pays an equal amount that is not shown on that statement. Also, they pay taxes that go towards unemployment benefits , and may be required to pay higher taxes if they churn through a lot of full-time employees. You can usually let contractors go with relative impunity .
For the unemployment tax reasons, not paying for people's days off or benefits, a lot less paperwork, and less risk to the business associated with committing to full-time employees all provide value to the company. Thus companies are willing to pay more because they are getting more.
Think of it like a cell phone-contract. If you commit to a three year contract it can be a pain/expensive to get out of the deal early, but you will probably get a better rate in exchange for the risk being shifted to your end of the deal.
There are a couple of reasons, including:
- The position of a contractor is usually more temporary and tenuous than a regular employee. They miss out on a certain amount of stability.
- Sometimes the contractor gets the contract because he has specialized knowledge or experience that the regular employees don't (not necessarily more or better, just different). That's worth something (at least for a while).
- Contractors also don't usually get benefits like health insurance coverage and the like.
- Contractors have to pay self-employment taxes (instead of having the company pay employment taxes for them).
All the existing answers are right and the general theme is: contracting is a different kind of relationship. It's a business-to-business relationship rather than a business-to-employee relationship.
This has implications such as:
- The contractor has to pay for any tools they need for the job.
- The contractor may be responsible for rectifying (serious) defects in their work at their own cost. In a way, they're implicitly being paid for results rather than for mere effort (as employees are), even if they're being paid based on the time they spend.
- The contractor only gets paid when they work. If they don't, for whatever reason, they don't get anything. It's the same as when you call a plumber to fix something: if the plumber happens to be sick that day it's their problem, not yours - you don't pay them for not showing up.
- There is no such thing as job security. To get fired as an employee you generally have to screw up pretty badly. As a contractor your contract can generally be terminated for no reason, at short notice and without compensation. If the company starts doing it tough the contractors are the first to go.
- Contractors don't get any of the benefits employees get.
- Contractors have to submit an invoice to get paid, which may well be delayed, disputed or (as already mentioned) simply not paid for no good reason. An employee has strong legal protection and some government agency will fight on their behalf for their wages. A contractor would have to take the company to court.
Of course, some contractors are effectively just over-paid employees, and some of the above points don't apply to them, but that's the idea behind bona fide contracting.
In addition to the other answers, consultants and contractors face a real risk (though admittedly small) of not getting paid. The more short-term the gigs are, the higher the risk of not getting paid for a particular job.
As an employee, there are laws to ensure that you get your paycheck.
As a contractor, you're just another creditor.
I know a couple of contractors (software engineers) who have had difficulty collecting after a job. (I'm not even sure one ever got paid the full amount.) I also personally witnessed a contractor show up for a job who was then told by the company that they unilaterally decided that they would pay half of their pre-arranged rate.
The "more money" aspect is only true if you ignore the lack of symmetry between employment and contracting.
- An employee gets paid every month irrespective of the amount of work available. The consequence of this is that employees are always kept "busy".
- A contractor is free to declare their own taxes, so can keep that bill "artificially" low. However, they also have to cover office, workspace and appropriate tools.
- Contractors also fail to get the benefits of healthcare, copayments on pensions and so on.
- Contractors can optimise their own work-time and take on additional work outside the confines of their main "job" and so gain additional income.
Consulting is another story altogether. Companies are willing to pay consultants for a number of reasons but the most important is deniability. If a decision is recommended and goes wrong then the consultants can be sued. Liability cover is expensive.
Cynicism aside, it often isn't cost-effective to keep specialists permanently on the payroll for tasks that are performed once a year.
Recently I've noticed that the nature of consulting is changing. Companies are starting to assemble brains-trusts of internal consultants who can create and manage projects while outsourcing only the labour-intensive data-collection roles.
Expect this to have a big impact on the management consulting industry.
Note too that being a contractor means that you will unavoidably have periods between contracts; you tend to be out of work more often than a salaried employee would. You need to set your rates so your average income, including those down times, adds up to a living wage including all those benefits that aren't being covered.
If a company hires a contractor, they understand that this is part of the trade-off. They avoid making a long-term commitment when they don't have a long-term need, and they accept that this convenience may cost a bit more in the short term.