By default the iPod uses a 128 kb/s bitrate, which is of substantial enough quality to not introduce too much audible compression, but it is not CD quality. I hear there are programs that will allow you to store the iPod default files in a larger capacity, which will increase the bit rate, and lessen the compressive effects, but I have not found this to be necessary.
I play my iPod through my car audio system as well, and it sounds great.