why are there separate contacts "on my Mac" and in iCloud?

The All on my Mac means the contacts saved in address book , they can include some contacts from iCloud , some groups created .

It's the choice of administrator to drag few contacts from All on my Mac to other groups or in All iCloud or vice - versa or randomly save any where .

Suppose there are three contacts in All on my Mac , Mr A , Mr B , Mr C , the contacts that saved in iPhone will be common between All iCloud , but not be same as In All on my Mac .

Mr B , Mr C will be in All iCloud of Mac and iPhone , But Mr A not necessarily saved in iPhone .

Note : you have to manually drag and drop contacts , there is no such settings done automatically , the reason behind if a person don't want to share all contacts from his Mac to iPhone even its signed in with same Apple ID and password on the same network , they can restrict the particular contacts to be synced .

Apple engineers have designed address book in this way only .

Note : when you are travelling on the road , do you carry iPhone and Mac , and iPhone is connected with Mac using hotspot and you are sharing network .

When you add a contact in iPhone Create and manage groups of contacts on iCloud.com - Apple Support

The iPhone and Mac are signed in with same Apple ID and password on the same network , contacts box is checked on both so they will sync see the details in these articles Set up and use iCloud Contacts - Apple Support

Use other contact accounts on iPhone - Apple Support

Keep contacts up to date across devices

To keep your contact information up to date across all your devices where you’re signed in with the same Apple ID, you can use iCloud.

Go to Settings > [your name] > iCloud, then turn on Contacts.

Alternatively, you can sync the information between iPhone and your Mac or Windows PC to keep the information up to date across iPhone and your computer. See Sync iPhone with your computer.

If you use iCloud for Contacts, your contacts are kept up to date automatically, and no options appear for syncing them with your computer.

When " on my Mac " section is enabled in Mac , those contacts are separated and not synced with iCloud ( " on my Mac " is not available in Mac OS catalina , but may be active in previous versions .

When you add a contacts in a group Create and manage groups of contacts on iCloud.com - Apple Support , groups are never shared even the iPhone and Mac are synced , however contacts are synced when mail is composed and sent from iPhone to Mac Send email in Mail on iPhone - Apple Support

Read the section - Add recipients .

Send feedback Product Feedback - Apple