You gain honor by killing someone within your level (greens to reds)
You lose honor by killing players way lower then you are level wise (the greys)
It is difficult to "farm" honor because of the ressurection timer. In order for honor to work in your favor, you must kill multiple targets in a short time. Keep in mind that a group of greens can kill you.
The more dishonor you lose, the more outlaw you become. You will not be able to enter some towns, guards will attack you on sight and other players can target you, even those of your faction (according to how Blizzard explained it awhile back)
So there is your penalty system in place, along with the ressurection timer. If you do not like the way it is going, I'd advise you to try a more different game, like Lineage 2, where you can loot other's corpse or stick with Diablo 2, where the hardcore mode has perma death.