Kerry's response today was pretty good:
http://www.nytimes.com/2004/08/24/politics/campaign/24CND-KERRY.html?hp
But I think he can be even more direct in connecting Bush's dishonesty and lack of accountability when it comes to negative campaigning to his dishonesty and lack of accountability when it comes to governing the country.
Showing toughness and defending himself is important, but Kerry also needs to show voters why it all should matter to them. It matters because Bush's failed record is hurting the country.
Here's my humble suggestion for the next Kerry attempt at this issue:
"No smear campaign ever got anybody a job, provided health insurance for a family struggling just to get by, or brought a soldier safely home to his loved ones. Under this Admin., x million people have lost private sector jobs, x million more people are without health insurance, and we're stuck in a quagmire in Iraq due to his use of evidence. Maybe Mr. Bush is satisfied with the way things are going, and that's his right. I think America can do better."
I think a statement like this would help but future Bush attacks in a questionable light and help keep the focus of the campaign where it should be - on Bush's failed record.