Taylor, who passed away at the age of 72 last month, is regarded as the club's greatest ever manager having taken them from the old Fourth Division to First Division runners-up in the space of just five years.
The former England boss also helped the Hornets to the 1984 FA Cup final and steered them into the Premier League for a second time in 1999 having returned to the club.
In addition to the statue, Watford will arrange an annual pre-season fixture to pay tribute to Taylor.
"With the blessing of Graham Taylor's family, Watford FC will move forward with two significant tributes to the late Graham Taylor OBE. A statue of Graham is to be commissioned and sited at the stadium, with its location to be agreed with Graham's family and Watford Borough Council," read a statement from the club.
"In addition, a pre-season tribute fixture - which is expected to become an annual opportunity to remember Watford's greatest-ever manager - will be arranged to take place at Vicarage Road Stadium ahead of the Hornets' 2017-18 campaign.
"Watford FC is pleased to confirm that it will engage with fans' representatives to ensure that supporters play a lead role alongside the club in bringing the statue to life. Again, Graham's family are very supportive of these actions. Further details about both tributes will be published as soon as they are confirmed."
Taylor already has a stand named after him at Vicarage Road.