Jodjod said:
That's the beauty of it, if a player tacks on a "neutral" anything onto their sheet they feel they don't have to justify anything. :\
Haha... that reminds me of this actual conversation:
Player: Okay, so my druid is neutral evil.
Rest of us: This is supposed to be a more or less heroic game, and there's already a paladin in the party - no evil, sorry.
Player: Aha, but I'm neutral.
Us: You're still neutral
evil. That just means halfway between oppressive tyrant and psycho killer.
Player: But...
neeuuuutral...
Us: ...Are you still not seeing the "evil" part after that?
Funny thing was, the player wasn't exactly an inexperienced gamer or anything... she is blonde though, that might count for something.

I've exaggerated nothing here - right down to the drawn out "neeuuutral" as she pleaded her case.
More on topic, the aforementioned paladin went on to slaughter orc babies, along with entire noncombatant orc families, as they slept. Did I mention the paladin was an orc himself, if that matters? Yeah... his rationalizing of it was great (after breaking in and snapping a young female's neck - "She was trying to scream for help! I had to kill her!"). I think by that point the player had actually tired of playing a paladin in a party of CN 8-Bit Theatre wannabes (now there's a few stories for another thread - I say it like it's a bad thing, but really I was the worst of 'em

), and was having his character being his fall from paladinhood. The session with the orc slaughter was simultaneously some of the best roleplaying and some of the funniest **** I've seen out of the entire group, ever.
Okay, I lie, it's not really a story for another thread, I'm about to tell it right here, and it's actually my most on-topic paragraph yet. My character is a warmage, closely patterned on Black Mage from the previously mentioned 8-Bit Theatre. Since I knew of the heroic-game-paladin thing, and I didn't really want to play a psycho anyway, I went with CN. I made a specific point of trying not to fall into the classic "CN = insane/no accountability" trap, and it can be tough. With that character, I'll help out my allies, though I'm hesitant if it involves personal risk where there was none previously. I'll laugh at the misfortunes of others, but won't go out of my way to inflict it. I'll be unnecessarily violent on occasions, but only when duly provoked.
So, returning to your original question: What would be done? Well, with the evil druid player, we basically talked her out of it before the game started. Somehow I doubt she was actually going to roleplay a good heartless-predator-type druid anyways. But that's not your issue - you have a player who's doing the opposite, roleplaying a pretty good CE without writing it on the sheet. So for an analogous situation, I'd have to consider what would happen if our paladin slipped completely into madness, or if my character acted more like his inspiration. I suspect that at a certain threshold, the DM would simply say to the paladin, "You're evil now, and your powers come from appropriate sources. Change that alignment line." Or he might not tell the player, and just let him discover it - same result eventually, though.

If my character slid closer to evil without me noticing enough to actually change my alignment... well, at some point the paladin (who we'll assume hasn't fallen, in this scenario) would run a detect evil, and the DM would probably inform him of an extra source of evil. At that point, if I then continued to act in a blatantly evil matter (as you allege your player is doing), I suspect it would eventually be open season on my character if he didn't distance himself from the party first.
Bottom line? If you're pretty sure he's evil, treat him as such. If he won't change it on his sheet, just treat it as though it were out of date, same as if he'd levelled up to 10 and his sheet still said '9' at the top. Wow... I did a lot of rambling to lead up to the same thing some others have said in a few lines. Hopefully at least someone found it entertaining.
--Impeesa--