Farmers do not own the water that flows through their property. This is a Riparian rights concern and is quite complicated.

Its definitely complicated. But the end of the story is that the government can not easily stop the farmers from using water in many of these drought stricken areas. Its going to be a big political battle

Then tax them at a rate equivalent to their environmental cost? I don't think this is complicated (except politically, of course). You just want everyone to carry the cost of their own externalities.

Two problems with that, typically unelected bureaucrats get to set the price, and political complexity is the worse kind.