Blog tags and categories are a little like pigeon holes. They help your readers enter the world of your writing for internet marketing, and find what they are looking for, perhaps along with new ideas they didn't know they wanted to look for.
Or, put another way, they are an organizing schema for helping Google assess the relevance of your blog posts in the context of a search for related content. Thinking about the organization of your website is part of the webmastering you want to do as a site owner.
If you vaguely remember being forced to do essay outlines in high school, you might recall that there are several main points in an outline, and each of those would have supporting sub-points. In blogging, categories are the main points and tags are the sub-points.
Categories should be limited to about 10 or less words or short phrases. As a marketing tool, you want your categories to be pretty broad. Psychotherapists, for example might use their main niches as categories -- Anxiety, Depression, Relationships, Stress, Substances Abuse, and so on. If you only have 3 niches, that's fine. Three is okay as a set of categories.
If you tend to blog about a wide range of emotions or emotionally motivated behaviors, you might have a category such as Motivators. You could assign a lot of different blog topics to this category, including:
holiday guilt, family stress
loneliness, heartache, rejection
fear, needs, family roles
Tags should also be limited. Twenty is plenty, forty is probably approaching brain freeze for the reader. So make these broad umbrellas too. Don't use various forms of the same word or even related words -- anxious, anxiously, anxiety, worry, worried, worry-prone, worriedly, scared, nervous, nervously, uncertain, unsure, undecided, etc -- should all be just one tag or category. Google's algorithm now figures out these related words so you don't have to play like a dictionary.
If you have a category of Motivators, you might then have tags such as Emotions, Moods, and Needs. So blogs that talk about anxiety, depression, fear, anger, guilt, shame and so on would be tagged with the Emotions tag and the Motivators category. Likewise blogs that talk about loneliness, joy, jealousy, empathy, might be tagged as Moods, and given the Motivator category.
The words or phrases in both tags and categories should be used at least once in the blog, but they don't need to be repeated. Google considers overuse of the same keywords (tags and categories are read as keywords by Google) as bad SEO -- let alone bad writing -- and may deduct "authority" points from your site ranking for keyword stuffing.
Other Rules of Thumb for Tags and Categories
Don't use proper names of people or places
Don't use obscure professional jargon
Only use acronyms in wide public use
Review quarterly and eliminate tags used only once
Combine as many as possible under one umbrella
If you display a counter for your categories so that visitors can see how many blogs you have written under each label, the counter can be a good way to decide what to write about when you have a little writer's block.
For example, in my own categories list, I had only 12 posts in the category of SEO a couple weeks ago, so I knew I should add to that, to help bring that number up. And looking at the variable sizes in the tag cloud, I saw that webmastering wasn't as often used as blogging. So I'm adding that tag to this post, and removing the SEO tag because I already have the SEO category and the redundancy is unnecessary.
By the way, about those high school essay outlines -- I always did mine AFTER I wrote the essay. Otherwise my essay and my outline didn't match. I suggest doing your tags and categories after you are done blogging, too.