The Patiti restaurant on the Plaza de Armas in Cusco is a don't-miss. Fine cloth tablecloths, impeccable service, complimentary garlic bread and pisco sours, and excellent food make it hard to beat. The menu is varied, and the Peruvian specialties like alpaca steak in blackberry sauce or ricotto rellena are excellent. For those wanting less exotic food, the pasta, such as fettuccini alfredo, is also excellent.
Also, they had one of the cleanest public bathrooms I've run across in Peru! An incal wall that the restaurant was built around helps the atmosphere, and musicians often come in to play. And although it is a luxury restaraunt, most Americans will find it much less expensive than you would expect.