Your file contains CR+LF line ending. (You can say `cat -vet inputfile` to figure that. Carriage returns would show up as `^M` in the output.)
The following demonstrates the effect of line endings on the output:
$ cat test.txt
The quick
brown fox
jumped over
the lazy
dog.
$ paste -s test.txt
The quick brown fox jumped over the lazy dog.
$ unix2dos test.txt
$ paste -s test.txt
dog.lazy er