Chris Pearson is one of the premier WordPress developers. He understands WordPress as well as anyone- and he has a post on his site that everyone should read, here is an excerpt:

categories are a powerful tool that bloggers can use to exercise precise control over content in a dynamic environment.

Unfortunately, the true power of categorized content has been masked by the one size fits all implementation you see everywhere on the Web—the proverbial long, ugly list of category links now appearing on a blog near you.

As luck would have it, that awful category list also turns out to be a very poor presentational strategy for your site… But why?

Why Your Category List Isn’t Doing You Any Favors

By giving users a list of categories to browse on your site, you are creating a psychological conundrum that usually leaves them with a severe case of analysis paralysis. This is a condition where users, when presented with too many options, end up selecting nothing at all.

Being presented with more choices, even good ones, can hinder effective action. In one study, doctors couldn’t make a decision when a second promising drug showed up.

— Fast Company, November 2007

Counter-intuitive? Maybe. Human nature? Absolutely.

Whether you’re selling products, writing copy, or designing interfaces, you can benefit from playing into basic human psychology. And interestingly, with Website categories, accommodating natural human behavior also turns out to be an excellent SEO strategy

Automated SEO and Content Management with Categories

At first glance, it seems convenient that WordPress automatically creates category pages, tag pages, and just about every other type of page you can imagine1. Dig a little deeper, though, and you’ll find that this form of page bloat is a remarkably poor site-building practice—it’s a condition that should be avoided whenever possible.

As far as blogs are concerned, categories are the single biggest contributor to both page bloat and link dilution, two of the most abominable SEO sins. Ironically, when used properly, these same categories hold the key to efficient, automated site optimization and content management…

The difference, of course, is all in how you use them. Armed with a bit of knowledge and a few lines of code, you’ll be able to use categories to:

display content however you like, wherever you like

link directly to interior pages—not to interstitial “bloat” pages like monthly archives or category archives

provide your users with a smarter, more intuitive way to browse content that may be of interest to them… read the rest at:

What Every Blogger Needs to Know About Categories — Pearsonified.

I like to think of Categories as the table of contents to your site (in this metaphor- tags would be the index)- they are there to help a reader find what they are most interested in, and to group posts of a similar nature.

They are also a powerful tool to refresh old content in Google’s eyes- by collecting old posts with new posts Google sees the category as a new mix of keywords every time you add content to a category.

We can also use categories to present information in different places or in different ways if we want, but for the most part, they are a critical component of navigation. Read Chris’s whole post to learn more.