I think it was originally coined by Jim Nelson and Kathy Enders of Bloomington Minnesota, in 1964.
The story goes:
After a mishap with matches and a neighbor's grill, Jim's pants caught fire. He ran wildly down the street screaming, "I didn't do it." Kathy, not wishing to be blamed for the mis-hap, but still worried about her friend, yelled, "The Liar, The Liar, his pants are on fire!!
It is a paraphrased version of the 1810 poem �The Liar� by William Blake, reprinted here in full.
Deceiver, dissembler
Your trousers are alight
From what pole or gallows
Shall they dangle in the night?
When I asked of your career
Why did you have to kick my rear
With that stinking lie of thine
Proclaiming that you owned a mine?
When you asked to borrow my stallion
To visit a nearby-moored galleon
How could I ever know that you
Intended only to turn him into glue?
What red devil of mendacity
Grips your soul with such tenacity?
Will one you cruelly shower with lies
Put a pistol ball between your eyes?
What infernal serpent
Has lent you his forked tongue?
From what pit of foul deceit
Are all these whoppers sprung?
Deceiver, dissembler
Your trousers are alight
From what pole or gallows
Do they dangle in the night?
Blake, a romantic known for his colorful use of supernatural and ballistic imagery, pretty much settled the question of whether or not honesty is the best policy with that poem.