Your problem doesn't involve the bitrate of the files you are playing. 128 kbps AAC files will sound fine through your receiver (not muffled as you describe). Your problem must involve how you have it hooked up.
As anamorphic96 said, you don't want to be using the phono input.
I've read that the color scheme on the ipod cable is a bit tricky. You may be trying to run the video cable as one of the two audio cables. You can peruse through the comments here:
http://store.apple.com/1-800-MY-APP...Qf71zFrnISk/1.SLID?mco=543CBB30&nplm=M9765G/A
Definitely don't waste your money on a fancy dock. It really is pretty much worthless, especially for $100.