UPDATE 3-In speech, Obama to challenge divided Congress to back his proposals
* State of the Union speech to focus on economy
* Wants not bigger government, but "smarter government"
* Let free enterprise work, Republican Rubio urges
* Obama to announce 34,000 troops to return from Afghanistan
By Steve Holland
WASHINGTON, Feb 12 (Reuters) - President Barack Obama will challenge a divided Congress on Tuesday to back his proposals to create jobs for the middle class and produce a smarter, not bigger, government in a State of the Union speech that will lay out his second-term agenda.
"A growing economy that creates good, middle-class jobs - that must be the North Star that guides our efforts," Obama will say.
Obama will enter the well of the House of Representatives for a 9 p.m. EST (0200 GMT on Wednesday) address to a joint session of Congress at a time when he is again locked in a bitter battle with Republicans over taxes and spending, and this tussle will cast a heavy shadow over his appearance.
Seeking to use momentum from his re-election victory, the Democratic president will urge Congress to adopt his proposals to increase taxes on the wealthy, overhaul U.S. immigration laws and enact tighter gun controls.
Obama's speech marks a renewed focus on the U.S. economy as he tries to satisfy American worries about a stubbornly high unemployment rate of 7.9 percent.
The White House has signaled Obama will urge U.S. investment in infrastructure, manufacturing, clean energy and education, despite Republican opposition to increased government spending and a political divide over how to tame the budget deficit.
According to speech excerpts released by the White House, Obama will speak up for the middle class.
"It is our unfinished task to make sure that this government works on behalf of the many, and not just the few; that it encourages free enterprise, rewards individual initiative, and opens the doors of opportunity to every child across this great nation of ours," he will say.
Obama will fight back against Republicans who say he simply wants to close tax loopholes enjoyed mostly by the wealthy in order to produce more revenue for government spending, instead of paying down the staggering national debt of $16 trillion.
He will say his additional proposals are fully paid for and consistent with a budget framework both parties agreed to 18 months ago.
"Let me repeat - nothing I'm proposing tonight should increase our deficit by a single dime. It's not a bigger government we need, but a smarter government that sets priorities and invests in broad-based growth," he will say.
Florida Senator Marco Rubio, a rising Republican star who will deliver his party's response to Obama's speech, will say that tax increases will not produce needed jobs nor reduce the deficit, and that government spending needs to be reined in.
Rubio is to make an impassioned plea to let the free enterprise system work.
"Economic growth is the best way to help the middle class. Unfortunately, our economy actually shrank during the last three months of 2012. But if we can get the economy to grow at just 4 percent a year, it would create millions of middle class jobs," Rubio will say, according to speech excerpts.
Just three months after winning re-election on Nov. 6, Obama has a narrow window to push through policy priorities on the economy, immigration and gun control.
Analysts say he has roughly a year before Washington turns its attention to the 2014 mid-term elections, which could sweep more Republicans into Congress and accelerate the subsequent "lame duck" status that defines presidents who are not running for office again.
"He basically has a year for major legislative accomplishments because after the first year you get into the mid-term elections, which will partially be a referendum on his presidency," said Michele Swers, an associate professor of American government at Georgetown University in Washington.
On foreign policy, Obama will outline steps to unwind U.S. involvement in the unpopular Afghanistan war and plans to announce that 34,000 U.S. troops will return by early 2014, a senior administration official said.
The State of the Union comes less than 24 hours after North Korea conducted a nuclear test that Obama in a statement called a "provocative act." Obama is expected to address Pyongyang's latest action in his speech.
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