The two party system is harmful and should be dismantled.
It dilutes the balance of powers set up by the founders. The founders chose three branches because triads are unstable. This instability makes it difficult to control by those, whom the founders foresaw, that would want to use the government to promote their own interests. This inherent instability is diminished when all three branches are controlled by only two parties.
It constrains the open exchange of ideas. When there are only two parties many of the harder decisions, that neither party wants to address, can conveniently be ignored by both. A good illustration of this is the deficit during the Bush/Clinton election. Neither party was talking about the obvious problem of the ballooning deficit until Ross Perot made it an issue that could no longer be ignored. Parties choose issues based on what they can win on, and then elevate those issues, not the problems that the nation really faces. Consider the Gay Marriage issues raised in the 2004 elections. This was not pulled to the forefront of political debate because it was a real problem that everyone knew needed to be addressed. It was artificially elevated because it was an issue that would draw strong support from certain segments of the populace and would bring people to the poles. Parties use these kinds of political tricks because they work and they work only because of the limitations enforced by the two party system.
It limits compromise and negotiation. The two party system rewards partisan behavior that boils disagreements down to 'them verses us' conflicts that are settled more by party power and influence than real debate, negotiation, and compromise.
We don't need a third party, what we need is to dismantle all laws, house and senate rules that support the two party system. This will need to be done on all levels of government (federal, state, and local) but should probably start in the state and local levels.