The Handmaid's Tale takes place in a city in what used to be in the United States, now called the Republic of Gilead. In this alternative future state, the democratic government has been overthrown and replaced by a totalitarian one. What makes Gilead so scary is that it still looks pretty much the same, but its government and society are totally alien from our own. Gilead seems to be without freedom or choice.
One of the most terrifying things about Gilead is how it seems to permeate everyone's psyches. The narrator first hears this when she's being reprogrammed at the Women's Center: "The Republic of Gilead, said Aunt Lydia, knows no bounds. Gilead is within you" (5.2). Yikes. We mean, even if you lived somewhere really nice, would you want the city to be inside you? There's no getting away from this society's beliefs, ever. They're always with you, because they're "within you."
The narrator describes the city she lives in as follows:
The lawns are tidy, the façades are gracious, in good repair; they're like the beautiful pictures they used to print in the magazines about homes and gardens and interior decoration. There is the same absence of people, the same air of being asleep. The street is almost like a museum, or a street in a model town constructed to show the way people used to live. As in those pictures, those museums, those model towns, there are no children.
This is the heart of Gilead, where the war cannot intrude except on television. (5.1-2)
Sounds kind of like Stepford, right? It also sounds like the terrifying city on the planet Camazotz in A Wrinkle in Time . It's fair to say that Gilead resembles both of those places in that the people have become eerily homogeneous in behavior and appearance. The difference is that there aren't any children. Children bring life and energy to a place, and without them Gilead seems dark and empty. Notice that throughout the book we meet very few children, even though creating them is the object to which all adults aspire. Terrible wars are supposedly raging outside the city (the narrator only hears about this in snippets on television, which may be complete propaganda), inside the city, people are safe from the outside forces of death and destruction. It's the ones inside they have to worry about.
Gilead is based on Cambridge, MA, specifically the Harvard area, outside Boston. According to an interview she gave to the New York Times, Atwood made this choice because of the region's Puritan background and history of intolerance:
You often hear in North America, "It can't happen here," but it happened quite early on. The Puritans banished people who didn't agree with them, so we would be rather smug to assume that the seeds are not there. That's why I set the book in Cambridge. (source)
Atwood has a personal connection to this too, since one of her relatives, to whom The Handmaid's Tale was partially dedicated, nearly died by hanging at the hands of the Puritans (source). Even with that personal connection aside, it's easy to see how the idea of something so frightening "not happening here" can so easily be proven wrong.