Lai's remarks came days after US President Donald Trump suggested arms sales to Taiwan could be used as a bargaining chip with China, which claims the island is part of its territory and has threatened to seize it by force.
"Taiwan's future cannot be decided by foreign forces, nor can it be held hostage by fear, division, or short-term interests," Lai said in a speech to mark the second year of his presidency.
Trumps comments in an interview with Fox News and on board Air Force One followed a state visit to Beijing last week where Chinese President Xi Jinping pressed the US leader not to support Taiwan.
Since then, Lai's government has been on the offensive, insisting that US policy on Taiwan has not changed and that Trump made no commitments to China on arms sales to the island.
Taipei says China is the "root cause" of regional instability and US arms sales are a legal commitment to the defence of the island democracy.
In his remarks on Wednesday, Lai told reporters that his government was increasing defence spending to "prevent a war", not to start one, and noted that "threats are greater than ever before".
"Taiwan must have the capability to protect itself and to uphold peace and stability in the Taiwan Strait," Lai said.
Since Trump took office, Taiwan has been under intense pressure to spend more on its own protection and increase investment in the United States.
Taiwan has been pouring billions of dollars into upgrading its military and developing its own defence industry, but remains heavily reliant on US sales of high-tech weaponry that it would need in a war against China.
Taiwan's parliament recently approved a $25 billion defence spending bill that will be used for US weapons.
Lawmakers have said the funds will cover nearly $9 billion of the $11.1 billion arms package announced by Washington in December and a second phase of arms sales -- not yet approved by the United States -- worth around $15 billion.
Trump has said he is considering the arms sales and will decide "over the next fairly short period of time".
Xi began the Beijing summit last Thursday with a warning on Taiwan. The Chinese leader told Trump that missteps on the sensitive issue could cause "conflict".