The Sponge tool in Photoshop is designed for use on full-color images. Don't try using it on grayscale images because it doesn't do you any good. It's not that it doesn't work — it does — it just doesn't work correctly. On a grayscale image, the Sponge tool either lightens or darkens pixels like a shoddy version of the Dodge or Burn tool.

When you work on a color image, the Sponge tool increases or decreases saturation. Ever used the Color knob on your television? Turn the knob up, and the color leaps off the screen; turn it down, and the colors look gray. What you're doing is adjusting the TV's saturation. Increasing saturation makes the colors more vibrant; decreasing saturation makes the colors more drab. The Sponge tool works in much the same way.