Simon,
As Wes pointed out, I was incorrect when I referred to AAC as lossless. Those are two different codecs. AAC (which is mp4 as opposed to mp3 as Wes pointed out) is the format that iTunes downloads come in, and they are 128. But, because they're using a different codec than strick mp3s, they are able to have similar (or better) quality at lower bitrates. That results in similar (if not smaller) file sizes.
And yes, you can encode in AAC using iTunes, but most people don't do it because your average CD-burning program (Windows Media Player, Roxio EZ CD Creator, Nero, etc) doesn't (?) recognize AAC files to use for burning. Also, iPods are the only mp3 players that will play AAC files (once again, correct me if I'm mistaken), so that is why most people rip their CDs as mp3s instead of using AAC.
But you can do both of those (plus at least one or two other formats) using iTunes.
I hope that has cleared things up for you. I know it's help make things a little clearer for me.