Let's just get it out of the way. Yes. The town's name is really Dildo. And dammit, if the locals have anything to say about it, their town will continue to be called Dildo, no matter what naysayers want.
The island and area of Dildo has held its name since at least the early 1700s, likely predating any connotation to sex toys, however the origin of the name is not totally clear either. The best guess as to the origin of the name is that it recalls when "dildo" simple meant any cylindrical tube (for example, a test tube could be called a "dildo glass"). It has also been theorized that the region gained its name from the irascible explorer Captain Cook, who was not above giving locations joke names.
Regardless of where it came from, the modern meaning of the name is certainly well known, and many have found the town's name to be offensive, filing petitions to have it changed. However, the majority of the stubborn fishing community of Dildo is just fine leaving the name as it is. This could be because of the tourism that the controversial name has brought to the area in recent years.
To capitalize on the funny name, the town now hosts an annual festival known as Dildo Days, which is of course led by the whimsical mascot, Captain Dildo. He looks like the Gorton Fisherman.