This was causing Trac #10627.
See Note [Substitute lazily] in CoreSubst.

The bug was introduced by
   commit 30c17e70
    Author: simonpj@microsoft.com <unknown>
    Date:   Thu Nov 25 17:23:56 2010 +0000
    Substitution should just substitute, not optimise

The fix is not to optimise the RHS as well as not-optimising the LHS!
The simplifier does the right thing in Simplify.simplRule