I have been working on an Android project from past one year in Eclipse with API level set to 4.2 (target SDK 17). Now I want to publish it in the Play Store. Should I change the target SDK (manifest file) to the latest (i.e. 4.4) since my app works perfectly on KitKat?
The purpose of targetSdkVersion is explained in the developer documentation for <uses-sdk>:
This attribute informs the system that you have tested against the target version and the system should not enable any compatibility behaviors to maintain your app's forward-compatibility with the target version. The application is still able to run on older versions (down to minSdkVersion).
As Android evolves with each new version, some behaviors and even appearances might change. However, if the API level of the platform is higher than the version declared by your app's targetSdkVersion, the system may enable compatibility behaviors to ensure that your app continues to work the way you expect.
TL;DR: You should set targetSdkVersion to the API level that you've primarily been developing and testing on. Google recommends that you see to it that this is the latest Android version, but that may not always be feasible (for financial and other reasons).