Steve,
 You might want to take the CAT off and check inside to see if the packing is
allright/ still there.  When I bought my 87 syncro it did not pass MA
inspection either,  which lead me to find out the O2 sensor was bad.  It was
frozen to the CAT as is yours, so I took the CAT off and found that there was
no packing in it or rather it had aparently burned up.  The O2 sensor had been
sending faulty signals creating an enormous amount of heat / and high CO which
is the possible cause for the empty CAT.  This was "confirmed" by the local VW
dealer.  A new O2 sensor and  CAT  corrected the problem and I passed no
worries.  If your CAT is bad you could pay $995.00 through the dealer or you
can pick up an aftermarket  one through the Bus depot for $99.95 (not missing
a zero).  Besides if its the CAT then you won't have to deal with trying to
remove the pain in the ass old O2 sensor.  Fairly easy job either way.
Good luck
Chris