Little Boy Liar--and Bully to boot?

T1's been lying to me.  A lot.  He never takes responsibility for his actions and is constantly trying to either pass the buck to someone else (most often, T2) or he rationalizes behavior with a disclaimer, "I didn't mean to..."  I'm aware that little kids lie, and punishing them for lying, seems to me, is an invitation for more lying.  I mean, he's already scared to tell me the truth if he's lying, so if I come back with a, "Don't you lie to me...." threat, he's going to shut down and tell me nothing.  I suspect, if he's afraid to tell me anything he's done that can be misconstrued as outside my expectations for good behavior, this will become his pattern for sharing information with me at all as he grows up--avoiding it.

So how do I deal with this?  I want to raise children who have integrity, who feel responsible for how their actions might affect other people.  At what point am I making a big deal out of a small infraction, and at what point do I have to intervene?

This week, it was brought to my attention that T1 has been harassing an older boy at school.  When I asked him why he did it, he completely denied it.  (I know he did it because I have confirmation from 2 other people, and like I said, he's been lying to me.)  It took a full day before he admitted to being involved in the situation, and even then, he made light of it, and instead of saying he was sorry or having any remorse, he blew it off and changed the subject.  I am disturbed by this on so many levels.  First, he doesn't seem to have any understanding of the other boy's feelings.  Second, he doesn't appear to understand that when he lies to me, my trust in him is totally compromised.  Third, and this is my own neurosis, I worry that he's on the road to being an inconsiderate jerk who, without any consequences for misbehavior, will grow into a sociopath.

DG and I talked about how to deal with this situation.  After consulting with our trusted parenting advisor, we concluded that our job is not to threaten him with consequences for lying, bullying or misbehavior, because they will build a wall between us that will grow taller and taller over time.  I mean, what's the recidivism rate among criminals released from prison?  Do they respect authority? Rather, we need to redouble our efforts in teaching him right from wrong so that it becomes his idea to do the right thing on his own, and while I thought he already knew this, each new developmental level presents a new opportunity for a moments to teach him our values.  Respect, kindness, compassion, hard work, and self-respect.

I'm willing to relate to him in a completely different way that will teach him that what I do, and not the empty threats that I want to say, is how grown ups behave. 

Still, parenting conventions indicate that I need to