The federal government was within its right to spend employment insurance funds on related social programs, but broke the law for three years when it turned the premiums workers pay into an unlawful payroll tax, Canada's top court ruled on Thursday.

In a unanimous judgment Thursday, the court rejected claims by two labour unions that the former Liberal governments of Jean Chrétien and Paul Martin unconstitutionally used a massive EI surplus to balance the budget and support social initiatives.

Quebec-based unions Confédération des syndicats nationaux and Syndicat national des employés de l'aluminum brought the case to court, accusing the government of diverting premiums from the EI system that should've been used on jobless workers.

But the court only questioned the way the government handled the employment insurance fund in three of the past dozen years.

In 2002, 2003 and 2005, the court said the federal cabinet directly set EI premium rates without proper authorization from Parliament.

That violated "an ancient but fundamental principle of our democratic system," wrote Justice Louis LeBel on behalf of the unanimous court.

"According to that principle, a tax can be imposed only by Parliament or a clearly authorized delegate of Parliament."

The court made no comment on how to remedy the situation, and suspended the legal effect of its judgment for 12 months to give the government time to respond.

In the 2008 budget, Stephen Harper's Conservative government vowed to set up an independent Crown corporation to manage the EI surplus and ensure it was spent on unemployed workers. But the government didn't offer to restore the $54 billion critics say was diverted from the system to balancing the books and funding other programs.

LeBel found no legal reason to conclude the Liberals deliberately used the EI system as a cash cow.

"The government considered these surpluses to be part of public revenues and did not agree with returning them to contributors. However, this is not the place to discuss the appropriateness of this policy approach," said the ruling.

The judgment also affirmed the federal government's constitutional right to run training, job placement and other programs under the umbrella of the EI system.

"Regulating unemployment insurance does not mean simply taking passive responsibility for paying benefits to Canadian workers during periods when they are not working," the ruling said.

The labour unions had argued the government is strictly limited to paying benefits to workers who lose their jobs and that related social services should be under the purview of the provinces.

"It is clear that the [employment insurance] account does not constitute — as is the case of pension fund assets — a trust fund or patrimony by appropriation. It forms part of Canada's government accounting, and premiums form part of the government's revenues," the ruling said.

The account began ballooning after the Liberals brought in new rules in 1996 tightening eligibility rules for benefits.

Auditor General Sheila Fraser repeatedly criticized the government for the way it has handled EI since 1999.

With files from the Canadian Press