A definition of social overhead capital based on an ‘externality’ approach is proposed to explore the principle underlying cost sharing of social capital formation. First, in considering the relation of social capital to social services, the conventional ‘institutional’ definition and the simple ‘functional’ definition of social capital are criticised on the basis of their nonacademic and inconsistent interpretation. I propose instead a consistent definition of social capital based on an economic analysis of its external effects. Second, by separating the production side from the consumption side of public services in the public sector (and also in the private sector), four types of externalities of social capital (to the private sector) are distinguished. Finally, it is shown that these externalities can be taken as the theoretical bases for developing rules for cost sharing of social capital formation under the criterion of best allocation of resources. A forecast is then made of the size of these externalities, together with their feasibility of acceptance in actual public policy.