I am astounded that people would question citing an arxiv paper. If you get an idea from somewhere else, you cite it. This doesn't even have to do with the archive. I have on multiple occasions read papers where the author wrote a proof and then cited "private communications" with another mathematician as the source. In a business where ideas are ideas, you should always cite the source. Anything else is extremely dishonest.

edit: To be clear, I am personally entirely okay with not citing papers containing ideas you were unaware of during your own formulation (though I think if you become aware of it, you should probably point out that it was previously independently discovered by someone else). Your paper may still have merit even if it's idea isn't "new" (especially if the first paper is shit as is often the case).

edit2: I personally don't see much wrong with Yoav Goldberg's blog post linked in this blog post. It's refreshing to hear his honest opinions out loud. As a graduate student I always lost a little sanity each time I read a paper with "great ideas", but terrible follow-through (i.e. explanation and proof of those ideas). I personally think that clarity of exposition is at least as (if not more) important than the novelty of an idea. However, you should still cite the sources of your ideas. Feel free to point out the source's flaws, but cite them nonetheless.

(Hopefully no more edits...)