Your "fugly code" example suggests that you want to allow nesting of (cat ... ^cat) blocks, and that everything in the outer block should then get a single '#' inserted; and further, that if the final block is missing its closing "^cat" tag it should comment to the end of file. If both of those behaviours are required, then I'd probably prefer to stick with your example code - it makes it pretty clear what is going on, and could easily be extended to insert extra '#' characters for nested blocks if desired.

jo37's solution is nice, but does not handle nested blocks: it will stop commenting as soon as it sees the first "^cat".

If the "comment to end of file" behaviour is not desired, you may be better off with a recursive regexp that would only match balanced blocks.