A category is for a high-level grouping of related products. For example, if you sell clothes, you might create categories for "Men's", "Women's" and "Children's" clothes.
A tag makes a product easier to find by adding words that a visitor to your site might use when searching. For example, someone searching for a shirt might type "Shirt", "Tshirt", "Tee Shirt", "T-shirt".
A product can only have one category but it can have any number of tags.
Products that are tagged can be shown as a single group of products on any page on your site using Featured products.