“I never do fairy tale people, I do people just as they are.”

Tremendous Trifles (1909), XVII: "The Red Angel"
Paraphrased Variant: Fairy tales are more than true — not because they tell us dragons exist, but because they tell us dragons can be beaten.
The earliest known attribution of this was an epigraph in Coraline (2004) by Neil Gaiman; when questioned on this at his official Tumblr account http://neil-gaiman.tumblr.com/post/42909304300/my-moms-a-librarian-and-planning-to-put-literary, Gaiman admitted to misquoting Chesterton: "It’s my fault. When I started writing Coraline, I wrote my version of the quote in Tremendous Trifles, meaning to go back later and find the actual quote, as I didn’t own the book, and this was before the Internet. And then ten years went by before I finished the book, and in the meantime I had completely forgotten that the Chesterton quote was mine and not his.
I’m perfectly happy for anyone to attribute it to either of us. The sentiment is his, the phrasing is mine.
Paraphrased variant: Fairytales don’t tell children that dragons exist. Children already know that dragons exist. Fairytales tell children that dragons can be killed.
Appeared in Criminal Minds 2007 episode Seven Seconds ( IMDB quote entry http://www.imdb.com/title/tt1103432/quotes?item=qt1184717)
Context: Fairy tales, then, are not responsible for producing in children fear, or any of the shapes of fear; fairy tales do not give the child the idea of the evil or the ugly; that is in the child already, because it is in the world already. Fairy tales do not give the child his first idea of bogey. What fairy tales give the child is his first clear idea of the possible defeat of bogey. The baby has known the dragon intimately ever since he had an imagination. What the fairy tale provides for him is a St. George to kill the dragon. Exactly what the fairy tale does is this: it accustoms him for a series of clear pictures to the idea that these limitless terrors had a limit, that these shapeless enemies have enemies in the knights of God, that there is something in the universe more mystical than darkness, and stronger than strong fear.

in response to a mother who wanted her son to become a scientist and asked Einstein what reading material to give him
Found in Montana Libraries: Volumes 8-14 (1954), p. cxxx http://books.google.com/books?id=PpwaAAAAMAAJ&q=%22more+fairy+tales%22#search_anchor. The story is given as follows: "In the current New Mexico Library Bulletin, Elizabeth Margulis tells a story of a woman who was a personal friend of the late dean of scientists, Dr. Albert Einstein. Motivated partly by her admiration for him, she held hopes that her son might become a scientist. One day she asked Dr. Einstein's advice about the kind of reading that would best prepare the child for this career. To her surprise, the scientist recommended 'Fairy tales and more fairy tales.' The mother protested that she was really serious about this and she wanted a serious answer; but Dr. Einstein persisted, adding that creative imagination is the essential element in the intellectual equipment of the true scientist, and that fairy tales are the childhood stimulus to this quality." However, it is unclear from this description whether Margulis heard this story personally from the woman who had supposedly had this discussion with Einstein, and the relevant issue of the New Mexico Library Bulletin does not appear to be online.
Disputed
Variant: "First, give him fairy tales; second, give him fairy tales, and third, give him fairy tales!" Found in The Wilson Library Bulletin, Vol. 37 from 1962, which says on p. 678 http://books.google.com/books?id=KfQOAQAAMAAJ&q=einstein#search_anchor that this quote was reported by "Doris Gates, writer and children's librarian".
Variant: "Fairy tales ... More fairy tales ... Even more fairy tales". Found in Breaking the Magic Spell: Radical Theories of Folk and Fairy Tales by Jack Zipes (1979), p. 1 http://books.google.com/books?id=MxZFuahqzsMC&lpg=PP1&pg=PA1#v=onepage&q&f=false.
Variant: "If you want your children to be brilliant, tell them fairy tales. If you want them to be very brilliant, tell them even more fairy tales." Found in Chocolate for a Woman's Heart & Soul by Kay Allenbaugh (1998), p. 57 http://books.google.com/books?id=grrpJh7-CfcC&q=brilliant#search_anchor. This version can be found in Usenet posts from before 1998, like this one from 1995 http://groups.google.com/group/rec.music.beatles/msg/cec9a9fdf803b72b?hl=en.
Variant: "If you want your children to be intelligent, read them fairy tales. If you want them to be very intelligent, read them more fairy tales." Found in Mad, Bad and Dangerous?: The Scientist and the Cinema by Christopher Frayling (2005), p. 6 http://books.google.com/books?id=HjRYA3ELdG0C&lpg=PA6&dq=einstein%20%22want%20your%20children%20to%20be%20intelligent%22&pg=PA6#v=onepage&q=einstein%20%22want%20your%20children%20to%20be%20intelligent%22&f=false.
Variant: "If you want your children to be intelligent, read them fairy tales. If you want them to be more intelligent, read them more fairy tales." Found in Super joy English, Volume 8 by 佳音事業機構 (2006), p. 87 http://books.google.com/books?id=-HUBKzP8zsUC&lpg=PP1&pg=PA87#v=onepage&q&f=false

Source: Charles Dickens (1906), Ch 4 : "The Pickwick Papers"

Zheng Yuanjie (2004) in: "Zheng Yuanjie's 19 years in fairy tales" on chinadaily.com.cn, May 10, 2004 ( online http://www.chinadaily.com.cn/english/doc/2004-05/10/content_329434.htm).

Source: I'm In No Mood For Love

Source: The Amazing Maurice and His Educated Rodents

Kelly (1956) as cited in Editors of People Magazine (2007) The Royals: Their Lives, Loves and Secrets. p. 62

“A Fairy Tale and the End,” p. 40
The Sun Watches the Sun (1999), Sequence: "Forgotten Place”