1) The hoe flattens to where you're standing normally, or to where the tool is aiming if you hold shift. The tool can only change terrain so much from where it was. If you want to lower terrain a lot, you're going to need a pickaxe. If you want to raise it a lot, you need to use the Raise option.

2) Attacks are based on which bosses you've killed. Enemy health scales based on the number of players nearby. If you're by yourself, there's no scaling.