Here's what could happen....
You're going to rile someone up in the government office, they'll come out and inspect, involve the health department and building department, then you're going to be forced to move your well out of the poop area at your own expense. The neighbor will be forced to put in a new septic at his expense on his own property. Lawyers will be involved at great expense to both you and him. Both of you will then despise each other forever and eternity no matter how it turns out.
I'd say try to work it out civilly, but it appears its already gone past that point.
Be really, really careful how you handle it when you decide to go to the government. You may want an attorney to do it for you. Good luck.
As for suing a city, before I was born, my father and a partner bought up about 20 acres on the outskirts of town and subdivided it into about 17 lots. My dad's partner took the large lot at the end of the street that was bordered by 3 streets. South border was the new street for their neighborhood, west border was a busy city street/road, and north border was a dirt county road (the city limits at the time). He had plans for a nice house with three stories, cascading down a hillside on the east of the lot, kind of like two walk-out basements stacked and a nice 3rd floor, facing the busy city street. Really neat. Sometime between the time when he bought the property and the time before he built, the city ran a mile and a half lone 8' diameter concrete drainage pipe that drained the north half of the airport, a planned industrial park, two planned subdivisions and a large school right under the busy street on the west side and ending in his lot! Then they cut another 8' pipe under the dirt road on his northern property line and continued to a retention pond. So, in effect, they put an open drainpipe into his property, made it a retention pond that overflowed into the other pipe before it left. Made the property worthless.
He sued. He won. What did he win? The city had to buy his property for what he paid for it. And they had to pay for the house plans that the architect drew up. And as I recall, they had to pay for some building materials that were already paid for. And that's about it. No pain and suffering, as they say....