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The land value is not "entirely externalities from other nearby stuff", unless you arbitrarily set it that way, which results in weird things like total land value going down as the result of consolidating multiple improved parcels.
I don't want to pretend that you don't have a point. This is in fact a point I've argued on the other side of against more radical Georgists who pretend LVT has no flaws whatsoever. It exists, it is a potential issue. And a nuanced, sophisticated version of Georgism would try to figure out a way to calculate this and either reduce the tax rate of someone based on how much of their land value was created by their own improvements, or use land tax revenue to give back directly to the people who are responsible for it (though this may be vulnerable to inaccuracies and corruption). Maybe you let large developers apply for a permit which exempts them from taxes caused by their own buildings, but you still tax them for the unearned rent on their land that is caused by other people's actions. Or maybe you make land assessment prices sticky that can't increase faster than a certain rate, so that rapid changes in land value from building things will increase its economic value immediately, without the tax price changing, which allows people to temporarily extract rent from them. But the tax rate slowly goes up towards the current value such that all of the long term value of the land caused by emergent social phenomena that no individual is responsible gets taxed and redistributed to everyone in society.
So ultimately, I think this is a niche problem which has potential solutions within the Georgist framework. Most people will still build the same as what they build now. Some people will actually build more if you remove nonland property taxes and force landlords to build to profit instead of squatting on valuable land. Only large developers relying on their own land value synergies will be disincentivized, and only if the land value tax makes no exceptions for them. It will cause some economic inefficiencies, but so do income taxes. Income taxes create tons and tons of inefficiency which are not niche. So if we're comparing system to a Georgist system, especially a nuanced Georgism which acknowledges the costs and attempts to mitigate them by having exceptions and setting tax rates below 100%, I still think it's the least bad tax.
It's not really a niche issue, as my "consolidation" point gets to. Suppose we have a tiny toy town. It's got two parcels across from each other (and nothing else). On one, the landowner builds a grocery store. On the other, the landowner builds a clothing store. The values of both parcels increase! Perhaps we can assume that 50% of the increase from the grocery store parcel is due to the presence of the clothing store, and 50% of the increase of the clothing store parcel is due to the grocery store. Whoopee, we can now feel free to tax away that unearned 50%. But suppose they were the same landowner, and he consolidated the parcels before improving. Now all of that increase must be due to the landowner's own efforts, and we can't tax it away (or if we do, we're clearly taxing away the landowner's own contribution).
Abandoning my toy town, the issue is that if only 5% of a landowner's land value comes from their own efforts, it also means that only 5% of the value they add is retained by them; the other 95% goes to other landowners. In real life of course it would not be entirely symmetric and some landowners (e.g. of unimproved properties) would gain relatively more than others, but taxing it all away is strictly worse than accepting that situation.
Only the base land value they add is affected by this. They still retain 100% of the actual capital value of the improvement itself. A grocery store is useful for putting things in and selling them, and refrigerating them and keeping bugs out. It earns more profit than an empty parcel of land that sells groceries out in the open. The grocery store itself is valuable in its own right above and beyond the value it provides to the land around it for people who like living near grocery stores.
So we're not looking at a scenario where building a structure creates 10 million in land value but the owner keeps 500k with no tax, with 9.5 million being captured by nearby landowners, and we hope that the personal incentive is enough to pay for grocery stores as long as we don't tax it. We're looking at a scenario where building a structure creates 10 million in land value and 20 million in capital value, and the owner keeps 20.5 million: all of the capital and 5% of the land value, while 9.5 million is captured by nearby landowners who didn't build the building (unless we are in the niche toy town). Taxing the land will extract 33% of the value created as tax revenue, while reducing the personal incentive to build by 2.5% of its actual value, because the majority of the value is the untaxed capital.
Yes this does decrease incentives by some amount (and all my numbers are made up, so it could be the case that it turns out to be a higher proportion). But you have to get taxes from somewhere, and lands are unusually high in externalities: the majority of the value is not created by the same people who own the land, even if some is, and therefore an unusually efficient method of tax value extracted relative to personal incentive cost (from either an economic perspective or a philosophical perspective). For most other taxes, literally all of the value extracted was created by the person being taxed, and therefore is worse than a land tax in which only some was created by the person being taxed.
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