Bush accused Iran of spreading violence across the region, saying it was "funding and arming terrorists like Hezbollah - a group second only to al-Qaeda in the American lives it has taken".
He also addressed domestic issues, proposing cuts to curb climate change and health and education reforms.
He said the Iraq war had changed dramatically with the outbreak of sectarian warfare and reprisals.
"This is not the fight we entered in Iraq, but it is the fight we are in," he said.
He said Shia extremists backed by Iran and Sunni extremists aided by al-Qaeda and the "old regime" would take over in Baghdad if America "failed" in Iraq.
The US leader described al-Qaeda as "possessed by hatred and commanded by a harsh and narrow ideology".
"Take almost any principle of civilization, and their goal is the opposite.
"They preach with threats ... instruct with bullets and bombs ... and promise paradise for the murder of the innocent."
He said the most important mission in America's history was to "spare the American people from this danger" and asked for support for his plan to send an extra 21,500 US troops to Iraq.
A Washington-Post/ABC News poll released on Monday gave Bush a job approval rating of 33 per cent, showing him to be at the weakest point of his presidency.
In his address to a nation increasingly opposed to the Iraq war and to a congress which for the first time in his presidency is controlled by Democrats, Bush stressed the need for unity.
Bush also used the address to outline a domestic policy for the year.
"A future of hope and opportunity begins with a growing economy - and that is what we have. Unemployment is low, inflation is low, and wages are rising," he said, adding that more enterprise rather than increased government intervention was key.
He also called for Republicans and Democrats to overcome differences concerning the direction of social security spending.
He proposed a reduction in
Bush said that improved vehicle fuel standards and diversification of energy sources – such as the use of ethanol fuel – was necessary.
"It is in our vital interest to diversify
The energy proposals by Bush fall short of seeking mandatory caps on carbon emissions which are sought by some Democrats in the congress.
Bush is not pushing for a specific increase in the Corporate Average Fuel Economy (CAFE) standards, which many experts see as critical to reduce oil usage but which the White House fears would prompt manufacturers to build smaller, less-safe cars.
Instead, he will ask congress for authority to reform CAFE standards, with the goal of reducing projected annual fuel use by up to 8.5 billion gallons, according to Joel Kaplan, the deputy White House chief of staff.
Bush also called for doubling the strategic petroleum reserve from 727m barrels to 1.5bn barrels, in a bid to bolster
"Expanding the strategic petroleum reserve is a wise and a prudent policy decision that would provide an additional layer of protection for our nation's energy security," said Sam Bodman, the
Bush's move to increase troop numbers in Iraq
has not met with universal approval [AFP]
Meanwhile, Bush's health care plan will propose making health insurance taxable income and deductible up to $15,000 a year for families, starting in 2009.
The move could raise taxes for as many as 30m Americans but lower costs for many others.