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In this quote, Friedman (who was a conservative economist) is criticizing the liberal welfare state. He is saying that it penalizes people that work at gives benefits to those who do not. The system taxes work through income taxes and payroll taxes. These taxes are taken, for the most part, only from those who work. In that sense, workers are penalized. Friedman is saying that too much of that money is then taken and used to help people who do not work. This would be in the form of things like welfare payments or food stamps.
What Friedman is saying is that a system like this has the wrong incentives. It hurts people who work by taking their money in taxes and it helps those who do not by giving them welfare. This is a common conservative criticism of the American system to this day.
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