Beijing quickly denounced the speech on Saturday, saying it "distorts the truth" and reveals "ulterior motives."
Democratically governed Taiwan has faced increased military and political pressure from China, which views the island as its own territory over the strong objections of the government in Taipei.
Facing China's far larger military, which is adding advanced new weapons such as stealth-fighter jets, aircraft carriers and a huge array of missiles, Taiwan is ramping up defence spending and modernising its armed forces.
Peace cannot rely solely on "wishes", Lai said outside the Presidential Office. "Taiwan cherishes peace, but we will not give up our freedom. We are open to exchanges, but will not accept subordination."
Taiwan's resolve is not only a matter of its survival in the face of "authoritarian expansion", he added. "It is about whether the international community still believes that force cannot override rules, and that the powerful cannot strip a people of their right to determine their own future."
China's Taiwan Affairs Office said Lai's speech "disregards facts, distorts the truth, misleads the public, and reveals ulterior motives", accusing him of stubbornly clinging to "Taiwan independence" separatist thinking and exaggerating the "threat from the mainland".
"There is only one China in the world, and Taiwan is part of China – this is the true status quo in the Taiwan Strait," the office said.
Taiwan's future "can and must be decided jointly by all the Chinese people, including our compatriots in Taiwan," China's state television CCTV reported the office's spokesperson as saying.
China, which has never renounced the use of force to bring Taiwan under its control, calls the president a "separatist" and has rebuffed his offers of talks.
The US welcomes Lai's commitment to maintaining peace and stability across the Taiwan Strait, a senior US administration official said, adding, in reference to China, that "a routine speech is no justification for aggressive or coercive actions".
The United States is Taiwan's most important international backer despite the lack of formal diplomatic ties.
Lai said his government's increased investment in defence aimed to deter war, not provoke it.
"And we are strengthening our self-defence not to abandon dialogue, but to ensure that dialogue can take place on the basis of parity and dignity," he told the crowd at the event, where he also watched military displays and dancing performances.
"There must be respect for the right of the people of Taiwan to exist."
In 2024, shortly after Lai's first National Day speech as president, China held war games around the island but did not do so last year.
Its last war games near Taiwan were in late December, following news of an $US11-billion ($A16 billion) US arms deal for Taipei, the largest ever. US President Donald Trump has yet to approve a second package, worth $US14 billion ($A20 billion).
Lai urged democracies in the Indo-Pacific region to join forces to retain the status quo of peace and stability in the region.
Taiwan's National Day is held on the anniversary of a 1911 uprising that led to the overthrow of China's last imperial dynasty and the establishment of the Republic of China.
The Republican government fled to Taiwan in 1949 after losing a civil war with Mao Zedong's communists, and the Republic of China remains the island's formal name.
