Indeed, hence the sticky philosophical puzzler. I would think that the clerics themselves would start getting affected by the spell. Fortunately (for them), the effect of the spell when cast on someone of the same level as yourself is only deafness for 1d4 rounds. The Church could probably cover that up.

There was another interesting related situation that came up in an actual campaign I was in, involving the Blasphemy spell (a variant that only kills non-evil targets). My party and I were in our "home base", a mansion belonging to an allied NPC noblewoman, planning out our next excursion. A powerful demon we'd been tangling with attempted to scry-and-fry us, teleporting in and nuking us with Blasphemy. Unfortunately there were a lot of low-level NPC staff working in the noblewoman's household and the spell wiped them out instantly... except for one guy, who happened to be of evil alignment. He survived the encounter because of that.

Even though his alignment was evil, though, he'd never done anything wrong and didn't seem like he had any reason to do anything wrong in the future. So we weren't sure if we should fire him or what. It wasn't illegal to simply be evil, you had to actually do something evil before you could be punished. We just warned him we'd be keeping an eye on him, in the end, and kept him on staff.

What is being good except having self-imposed restrictions to avoid doing something evil? This spell seems perfect. There will rarely be a time where a good aligned character could justify using it in an overpowered way. If it were inverted then you would see evil characters using it all the time. It's a self-imposed balance. You have a very powerful tool, but you must avoid using unless absolutely necessary.

Almost as if the whole objective good vs bad system is kinda poorly thought out...

I feel like there might be interesting ways to deal with it. Perhaps the mass killing of neutrals only ever happened the first time, which could have been many generations ago and under singular circumstances. Since then, only the odd one here or there ever dies during the purge. Perhaps it's been decades or centuries since anyone died to the purge, reinforcing belief in it's effectiveness as a basis for a pure society. It may have been so long that people wonder whether the purge is even real, or just a traditional ceremony carried out annually based on old myths. Then one year, it wipes out half the city. The party investigates?

The system in question relied on a hard Alignment metric. So addressing each of your examples:

• A bum who does minor theft almost as a habit: Theft would qualify as a Chaotic act and would have no bearing on the Good/Evil axis
• A hateful bitter man who antagonizes everyone but obeys the law: This is a Lawful act and may or may not have an effect on the man's Good/Evil axis.
• Teenager: there is no alignment associated with angst
• A greedy business person who employs half the town but makes everyone’s life a bit worse: How he makes their life worse would matter in this instance, but he may be committing acts that affect his soul's alignment.

One of the things that everyone everyone forgets about this system is that Alignment has nothing to do with morality, but rather which prime plane the individuals soul was aligned with. Good is aligned with the Positive Energy plane, Evil with the Negative Energy plane, Lawful with Mechanus, and Chaos with Limbo. Each alignment also had a Power Word spell.

a hateful bitter man who antagonizes everyone but obeys the law

As one of those hateful bitter people in the eyes of others who still is lawful, I emphatically tell you that we are evil and absolutely would and should be killed by Holy Word and other such spells.

a teenager

Wait, what?

Actually everyone on your list should be killed by that spell, even the teenager though I vehemently disagree with that.

Like you can sit there and quibble about what is actually evil or not but this is magic, and what matters is what the majority of people consider evil, and they all hit the mark. Most adults are ageist bigots who'd wipe out all teenagers on a dime if they could, for example, even though that's pretty evil.

Good and evil are honestly pretty meaningless.

I hate these filthy Neutrals, Kif. With enemies you know where they stand but with Neutrals, who knows? It sickens me.

Here's the SRD entry for the spell. It definitely nukes the neutrals.

The evil equivalent is Blasphemy, which nukes all non-evil creatures. Yes, the neutrals get it from both sides.

Then there's Word of Chaos and Dictum, the Law and Chaos equivalents of those Good/Evil spells. Neutrals, believe it or not, death!

Pick a side, you neutral scum!

I hate these filthy neutrals. With enemies you know where they stand, but with neutrals, who knows? It sickens me.