The table cell should expand vertically to fill the height of the table. There should be no gap (no red) above or below the table cell.
border-spacing is not supported by IE 7. That's why I deliberately declared cellspacing="0" so that I could compare IE 7 and IE 8 beta 1 respective renderings without issues of unequivalent support.
CSS 2.1, section 17.5.3 Table height algorithms states that
that are smaller than the height of the row receive extra top or bottom
Internet Explorer 6, Internet Explorer 7, Firefox 1.5, Firefox 2.x, Firefox 3, Opera 9.26, Opera 9.50, Safari 2.0.4, Safari 3.1, Konqueror 3.5.8, NS 7.0, NS 7.2, Seamonkey 1.x, Seamonkey 2.x, K-meleon 1.x, Galeon 2.0.4, Epiphany 2.22 all pass this test.
Update: This bug has been FIXED in Internet Explorer 8 beta 2 (build 6001.18241) released on August 28th 2008. Otherwise, Internet Explorer 8 beta 2 PASSES this specific and particular testcase.