You make a fair point. A step between "fine" and "fallen" would be a great idea. I agree with you that paladin players should not be punished for having the temerity to play a paladin. I play one myself, and I'm appreciative of the fact that the DM doesn't expect me to act Lawful Stupid or Obnoxious Good. But look at the character's behavior in perspective.

The town mayor has been ignoring his duties for a while now to seek fame and personal fortune, and he's back in town. He refuses to arrest a man who murdered 2+ townsfolk in broad daylight. Seconds later, again in broad daylight in the middle of the town, he orders the death of a community leader who had committed no crime and then attempts to murder with his own hands a comrade who refuses to kill on command. In what sense can this mayor be understood to be upholding the principles of rigid, uncompromising devotion to order and authority? It seems rather that he doesn't give two coppers for the law and acknowledges no power greater than his own whims and desires. He's doing whatever he wants and whatever he thinks he can get away with.

The PHB says "Lawful characters tell the truth, keep their word, respect authority, honor tradition, and judge those who fall short of their duties. Chaotic characters follow their consciences, resent being told what to do, favor new ideas over tradition, and do what they promise if they feel like it."

We don't have all the detail here. It's certainly possible that I'm misreading the situation; I covered a variety of extenuating circumstances that could excuse the player's actions. But given what we know, my take on his behavior is that it was classic Chaotic Evil responses. That's a problem for a tyranny paladin.