iTunes does in fact offer the Apple Lossless Encoder. Obviously with a lossless (as opposed to "lossy") encoder, the file size will be considerably larger.
Yeah its better but not the same as lossless but then ipods were designed as portable devices where storage is key not audio quality. They are perfect for listening to through headphones just less so when used as an audio source.
I'd bet you couldn't tell the difference between a CD and the same lossless encoded track played through a new generation iPod hooked up to any of the Golf stereos. I'd even bet that no one here could differentiate between a 320K encoded mp3 and a CD, especially in a car that was actually moving; you could probably drop that to much more coarse encoding too and get away with it for most driving conditions or even any time the engine is running.
Seems like there's some subjective audiophile ignorance showing its ugly head here. I'd bet you'd even recommend people to use $$$ external DACs too.

For those that don't know, there's a
lot of ignorance and myth in the audio world, considerable amounts of which is championed by "high end" A/V salesmen that make their biggest profits from selling ridiculously over priced cables to the unsuspecting public.