When adding vital wheat gluten to a bread recipe, should one reduce the amount of flour equal to it?
I wouldn't replace milk powder with vital wheat gluten.  Vital wheat gluten changes the gluten content of your recipe.  It's good for, say, turning whole wheat flour with a lower gluten content or AP flour into flour suitable for bread.  

When I add vital wheat gluten, I subtract flour as your friend does.  I only use it when I am not using a high protein flour.

The dried nonfat milk powder is likely in the recipe for flavor.  I would instead use milk in place of water and either up the flour as needed or replace with flour as needed (you can tell this during kneading).  I've done this just fine in bread recipes before.