Taxonomy-A way to organize content

In Drupal , Taxonomy is a method of organizing content on a site. For example classifying music by genre could generate this list: classical, jazz, rock. A single area such as “classical” might be further classified as concertos, sonatas, symphonies, and so on

In Drupal 5 the naming of the Taxonomy module is inconsistent across the administrative interface. On the Administer >> Build >> Modules page, for example, the module is called Taxonomy. However vocabularies are administered through the Administer >> Content management >> Categories page.

In Drupal 6 the naming of the Taxonomy module has been made more consistent across the administrative interface. Settings for taxonomy.module can be found at Administer >> Content Management >> Taxonomy

You can enable the Taxonomy module on the modules page (administer >> site building >> modules).

These principles apply to defining a vocabulary with the Taxonomy module:

Each vocabulary consists of a set of terms.

1. A site can have an unlimited number of vocabularies each containing an unlimited number of terms.
2. Within a vocabulary terms can be ordered into hierarchies. In Drupal 6, all vocabularies are hierarchical (in other words, you can simply arrange items in a hierarchy). In Drupal 5 there is a setting for enabling hierarchical vocabularies.
3. Vocabularies may be designated as Free tagging in which users creating new content don’t have to classify it with terms from a “controlled vocabulary,” previously defined. Instead users can freely define terms, or “tags.”
4. Vocabularies can be set to allow terms to define related terms. This functions similar to “see also” in a dictionary.
5. Vocabularies define whether users may attach only a single term to a node or whether users may attach multiple terms to a node.

More details http://drupal.org/handbook/modules/taxonomy