Taylor oversaw some of the club's finest days during two spells in charge at Vicarage Road and believes that the Championship side can become a force in English football again.
Speaking at a dinner to commemorate Watford's appearance in the 1984 FA Cup Final, Taylor, who is the club president and also a non-executive director, told the Hornet's official website: "In 1977 when yours truly first came here, the natural level of our club, I would say, was top half of the fourth division, bottom half of the third division, and that's where the club was operating.
"It's taken us the best part of 32 years to get to know where the natural level of our club is; roundabout where we finished this season.
"Now that doesn't stop us being ambitious and stop us from getting into that Cup final again but we have to have a reality about things.
"And there is a reality now that's creeping into football that simply at the end of the day there's only one team who can finish at the top of the top division. We want to get back into the Premier League but what we have to do is be ambitious and give ourselves a base."