U.S. President Barack Obama says economic inequality is threatening the American middle class, and leaders must do a better job to create an environment where "hard work pays off, and responsibility is rewarded."

In his final State of the Union Address before the next presidential election, Obama laid out his plan to rebuild an economy that has been struggling through one of the great recessions of the modern era.

But the American Dream of a prosperous middle class was Obama's chief concern.

"The defining issue of our time is how to keep that promise alive. No challenge is more urgent. No debate is more important," Obama said.

The economy and growing inequality are both expected to be key campaign questions in 2012, and Obama's speech Tuesday was widely seen as a first step in drafting his strategy for the coming presidential showdown.

Since Obama took power three years ago, more Americans are living below the poverty line and unemployment remains stubbornly high at 8.5 per cent. Critics say the president has done little to improve the country's economic outlook.

Accordingly, foreign policy received less airtime in this year's address, while tax reform and recklessness on Wall Street were crucial.

"We can either settle for a country where a shrinking number of people do really well, while a growing number of Americans barely get by," Obama said. "Or we can restore an economy where everyone gets a fair shot, everyone does their fair share and everyone plays by the same set of rules."

To illustrate that point, Obama spoke of Debbie Bosanek, the secretary of billionaire Warren Buffett.

Bosanek, who gained attention after her boss revealed that he pays a lower tax rate then her, was seated in the first lady's box seat.

The spot is traditionally reserved for citizens who personify a key policy point, and both Bosanek and her boss have come to signify the growing income divide and a tax system that does little to address it.

The tax question also references Mitt Romney, the Republican millionaire who may take on Obama next year as the GOP's presidential candidate.

All week long, the Republican primary has been focused on Romney's $20-million income and the fact he pays less than 15 per cent tax on that money.

"Tax reform should follow the Buffett rule," said Obama. "If you make more than $1 million a year, you should not pay less than 30 per cent in taxes."

All eyes on the November election

But as is the norm in U.S. politics, the Republicans had already planned their rebuttal.

Indiana Gov. Mitch Daniels, who responded to Obama's speech, said that "no feature of the Obama presidency has been sadder than its constant efforts to divide us, to curry favour with some Americans by castigating others."

Daniels praised Obama for catching Osama bin Laden but slammed the president for not addressing the nation's huge debt problems.

"And yet, the president has put us on a course to make it gradually worse," he said, adding that Obama has used an experiment in "trickle-down government."

Indeed, Obama will have to defend himself and his policies against political rivals looking to unseat him in 2012.

In conjunction with Tuesday's speech, the Republican National Committee released a commercial aiming to remind Americans about their economic malaise and the ongoing uncertainty in the country.

According to the commercial, Obama is a failed leader who is to blame for "the 13 million unemployed and 49 million in poverty."

The ad aired in key battleground states like North Carolina, Michigan and Virginia.

But in his speech, Obama reminded Americans that the country has been suffering through the worst economic crisis since the Great Depression.

He also trumpeted the success of the resurgent American auto industry, and stressed that the U.S. needs to resurrect its manufacturing base.

"We bet on American workers. We bet on American ingenuity. And tonight, the American auto industry is back," he said. "What's happening in Detroit can happen in other industries. It can happen in Cleveland and Pittsburgh and Raleigh."

Following Tuesday's speech, Obama will head to campaign-style events in Michigan, Arizona, Iowa and Colorado, where he's expected to attack his political rivals with more tenacity.

But in the speech, Obama also set his sights on the next election, stating that his administration is focused on creating jobs at home by rewarding companies that build at home.

"My message is simple. It's time to stop rewarding businesses that ship jobs overseas, and start rewarding companies that create jobs right here in America. Send me these tax reforms, and I'll sign them right away."

Recent polling has shown that Americans are split on Obama's economic track record and his plan for creating jobs.

Still, Obama has also taken pains to blame the recession on his predecessor George W. Bush. Other key messages in the coming election will show that economic headwinds had already started before Obama took office.

Zeroing in on that claim, Obama's re-election team have released new figures that say monthly job loses had already began rising near the end of Bush's time in office. The graphic also portrays a trend of positive job growth during Obama's tenure.

Despite the looming election, Obama also asked that politicians "lower the temperature" in Washington, which has seen the two parties stuck in one long campaign full of heightened rhetoric and desperate political jabs.

"We need to end the notion that the two parties must be locked in a perpetual campaign of mutual destruction; that politics is about clinging to rigid ideologies instead of building consensus around common sense ideas," he said.

"The point is, we should all want a smarter, more effective Government. And while we may not be able to bridge our biggest philosophical differences this year, we can make real progress."

Canadian energy concerns?

While Canadian oil has recently became a topic of concern in the U.S. following the cancelation of the controversial Keystone XL pipeline, Obama spoke about the desire to produce energy domestically.

"Nowhere is the promise of innovation greater than in American-made energy," he said.

Though the president didn't specifically mention the Keystone XL pipeline -- which would take oil products from Alberta and transport them to refineries in Texas -- he said the U.S. needs to do more at home.

"Over the last three years, we've opened millions of new acres for oil and gas exploration, and tonight, I'm directing my administration to open more than 75 per cent of our potential offshore oil and gas resources," said Obama.

"Right now, American oil production is the highest that it's been in eight years … we relied less on foreign oil than in any of the past 16 years. "

With a report from The Associated Press