yeah. that's the main argument against giving candidates tests... that some people don't do well in a stressed situation like an interview. All I can say to that is you have to -try- to evaluate them.
Remember it's stressful for the interviewer as well as the candidate. The situation is unatural for both parties. In the end, the interviewer is trying to get a read on reality. That read is affected by the skills of both the interviewer and the candidate. It's also affected by whatever handicap each side incurs by virtue of the interview situation itself. So I guess there are 4 factors at play: skill of candidate, skill of interviewer, situational handicap of candidate, situational handicap of interviewer.
A simple programming exercise shouldn't cause someone to crumble. In an interview without a programming test, where you're only conducting probative discussions, a misread of the candidate could result from any of the 4 factors above. In an interview with a programming test, you get a reading where 2 of the four factors are not present. If a candidate can't complete the test (a properly designed/conducted test), then you're faced with 2 conclusions; either this guy can't code his way out of a paper bag or the interview setting itself occasioned a near total collapse of his faculties. In the first instance, the interview has worked as a filter with a bias toward exclusion. In the second, it's very difficult to pursue any further. There may be some way to overlook the result and make a case that he will nevertheless do well in some capacity at the company. Perhaps there's some undeniable track record of technological successes that he can offer. All I know is I have 3 more candidates coming in, and probably 10 more in the hopper for the rest of the week.