The smart alecky response to this question is: The Spanish Tragedy is a tragedy largely set in Spain. But, we'd be remiss not to mention that the play originally had a longer title, which is The Spanish Tragedy, or Hieronimo is Mad Again.
Um, when was he mad before? The easy answer is we just don't know. Wow, that really was easy. And no, the play is not a sequel. So, it's not something like, "Hieronimo is mad again, and this time with a vengeance" (spoken in big-action-film-trailer-voice). But we do wish this were true.
It could be that the longer title was merely intended to announce that there would be madness in the play. Madness was good entertainment in Elizabethan England. People actually paid money to visit insane asylums for entertainment purposes. It's not just that Elizabethan's liked crude forms of entertainment (they did)—it's also because they were clueless when it comes to insanity. The Renaissance happened way, way before modern psychology, which made insanity seem magical, otherworldly, and—strangely enough—entertaining. To be fair, Elizabethans also paid money to watch ginormous dogs rip bears to pieces.
But we digress.
Spain was England's greatest rival in the 1580s (complete with an invasion attempt and everything), so putting Spain in the title was a lot like having Rocky fight a Soviet boxer in Rocky IV. In the 1980s, the Soviets were America's biggest threat, so having Rocky beat the tar out of Ivan Drago made some people feel pretty darn good about America.
Check out how the film uses the Soviet boxer to characterize the communist threat. Yes, it's a cheesy video, but whether it's the 1580s or the 1980s, people tend to pay for films that tap into national threats and patriotism. But as far as we know, nobody wore fluorescent outfits in the 1580s. Anywho, by making Spain look like a place where crazy dudes kill murderous dudes, Kyd was basically dissing the whole country. And putting "Spanish" in the title put butts in the theater seats.
Oh yeah, one more thing: putting "tragedy" in the title announced that there would be tons of dead bodies on stage in the final scene: Spanish bodies, no less.