Legalism
"Legalism" is a pejorative term used to refer a few separate heresies. Often certain groups will follow multiple forms of it, but this is not required.
Types of Legalism
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Salvation by Works
The classic definition of legalism is a belief that people must do good works or follow some rules to earn salvation. This is contrary to the Bible, which teaches that salvation is a gift of grace to be received which no man can earn.
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Nomism
Possibly the most accurate definition of legalism is simply that it is synonymous with nomism, the focus on rules being the guide of a Christian's life. Legalism will be often be described as the "bad" form of nomism which bleeds over into salvation by works again, while nomism is a characterized as a more neutral rule-following. These connotations exist, but ultimately there is no strict difference.
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Elevation of Standards
The more modern form of legalism is people elevating their own standards on matters of conscience to the level of God's. They will take an issue that has no clear right or wrong answer about which Christians can reasonably disagree while enjoying full fellowship, and they will make their preference out to be the only acceptable choice. They will call anyone deciding differently sinful and possibly even unsaved.
While being the more modern form, this is an ancient heresy. The Pharisees were guilty of this, and Jesus rebuked them for it. Matthew 23:23 Paul continued to deal without throughout his ministry, as the Jews and the Greeks naturally had different standards. Paul had to set them straight. There is no right answer to matters of conscience, and we should not judge others for their standards:
Romans 14:10–13 But why dost thou judge thy brother? or why dost thou set at nought thy brother? for we shall all stand before the judgment seat of Christ. For it is written, As I live, saith the Lord, every knee shall bow to me, and every tongue shall confess to God. So then every one of us shall give account of himself to God. Let us not therefore judge one another any more: but judge this rather, that no man put a stumblingblock or an occasion to fall in his brother's way.
This is a serious issue, as it can lead to division in the church, it shows people a false, nomist version of Christianity, it can cause people to doubt their salvation, it promotes man's standards over God's, it adds to God's Word, it often leads to belief of salvation or sanctification by works, and it interferes with the church's mission to spread the Gospel. It must be opposed wherever it arises, and we must love those who practice different standards as our brothers and sisters in Christ.
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Having Standards
Finally, many deriders of Christianity will misuse the term to simply refer to anyone who has a standard, regardless of whether or not he makes it moral issue or encourages others to live likewise. Many people simply want to live life in the way that they think is best, regardless of what the Bible says.
Proverbs 14:12 There is a way which seemeth right unto a man, but the end thereof are the ways of death.
We must respond in love to such accusations, but ultimately we must stand firm in the truth of God's Word. His ways are higher than our ways, and we must trust Him to know what is best for us. Isaiah 55:8–9
Furthermore, we live the freedom of Christ. Those who live according to their flesh are not free themselves but are slaves to sin. We live for God because we love Him, not because we are trying to earn our way to heaven. We are free from the law, and we are free to live for Christ. Romans 6:18–22